40 cayman captive 2019
The speed at which yields rise matters. If the expected downward
adjustment in bond prices occurs gradually over an extended period, it’s
very likely that these fi xed income categories can deliver outperformance
due, in part, to their higher yields.
However, if the bond market experiences a more rapid sell-off—such as
those that occurred in the early 1980s, 1994, and the second quarter of
2013—then these areas are likely to suffer substantial underperformance.
Forecasting the direction of medium to longer-term interest rates,
however, is indeed a drill that puzzles even the shrewdest of investors. If
interest rates go up, you want to have investable cash to take advantage
of the higher rates; but if rates move lower, you want to have some money
invested at the higher rates.
The right plan
Investors should approach the market with strategies and approaches
that are appropriate for either scenario. Many investors prefer index funds
(ETFs) for their low costs and relative predictability, but a bear market is a
reason to consider the following investment approaches.
Actively managed funds
Active managers typically charge more in fees than their passively
managed counterparts; however, they also have the ability to shift their
portfolios to reduce risk and capture values as opportunities permit. In
this way, investors have the benefi t of a professional manager taking
steps to offset the impact of a bear market.
Unconstrained bond funds
“Unconstrained” is a term for funds that have the ability to “go anywhere”
in terms of credit quality, maturities, or geographies. This is the next step
from active management, since active funds can be limited to a particular
area of the market, credit rating and currency, whereas unconstrained
funds have no such restrictions.
A wider range of opportunities should, at least in theory, equate to a
greater number of ways to sidestep a market downturn.
Floating rate bonds
Rather than paying a fi xed rate of interest, these bonds have yields that
Investing in fi xed income remains the bedrock of investing for
Cayman captives. The key is designing an investment strategy and
approach to take advantage of fl uctuating interest rates while still
providing income, capital security, and possible growth.
While nobody knows for sure what the future will bring, when it comes
to fi nancial markets, it’s clear that the US Federal Reserve is signalling
higher interest rates into 2019. The next three to fi ve years may well
usher in an era of potentially low (or even negative) bond market returns,
and as such, investors should explore strategies now, which may help
to protect their portfolios while maintaining fi nancial fl exibility. With this
preface in mind, let’s look at some of the options.
Short-term bonds aren’t exciting, but they are conservative investments
unlikely to see substantial losses in a bear market. In contrast, longterm
bonds have much higher interest rate risk, and we have seen how
rising interest rates have crushed performance results for those taking
on lengthy duration.
In the period from May 1 to July 31, 2013, the bond market was hit
hard as the yield on the 10-year note soared from 1.64 percent to 2.59
percent (prices and yields move in opposite directions). During this time
period, the ICE 15+ year US Treasury Index (G8O2) was hit for a loss of
12 percent, while the ICE fi ve to seven-year US Treasury Index (G3O2)
declined 3.9 percent. In the same time period, however, the ICE one to
three-year US Treasury Index (G1O2) fell just 0.1 percent.
This helps illustrate that while short-term bonds won’t necessarily
make you money in a bear market, they are much less likely to suffer
signifi cant losses than their longer-term counterparts. Simply put: if you
want to stay safe, stay short.
Not all segments of the bond market react in the same manner to the
same set of stimuli. Over time, for example, sectors with higher credit
risk—such as investment-grade corporate and high yield bonds—
have demonstrated the ability to outperform when longer-term yields
inovated captures / iStock Photo
How to give your
captive fi nancial fl exibility
Many captives remain fi xated with investing in fi xed income
products, but that should not mean a lack of fi nancial fl exibility,
says Stephen Price of RBC Dominion Securities.