Building an investment portfolio: bonds, commodities and property explained
An investments portfolio doesn’t just have to contain stocks and shares. A well—diversified portfolio will contain other assets including bonds, commodities and property, which have different risk profiles. Here we look at some of these other assets.
Investing in bonds
When you buy bonds, you are lending money to a company or to a government.
A bond will guarantee to pay you an income each year at a rate of interest, known as the coupon, fixed until the bond’s maturity date. Remember that rate may or may not be above the rate of inflation — unless it is an inflation—linked bond.
Bonds are traded on the markets, and like stocks their prices will be affected by supply and demand and by external events, notably interest rates and the outlook for inflation. But they will probably respond to the big economic picture differently from equities, and be less volatile.
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Bonds are graded by the market according to the risk of not getting your money back, and the higher the risk the higher the promised return. So government bonds from Greece or Venezuela will tend to pay a higher rate of interest than UK gilts or US treasuries, as the government bonds from those countries are known as.
Corporate bonds are debt issued by companies to fund their activities — for instance, Apple has borrowed over $50 billion from investors, and pays its bondholders 3%—4% a year.
Corporate bonds that pay over a certain return are classed as high—yield, which means they are a higher risk than investment grade bonds.
Providing that the company (or government) doesn’t go bust, a pay out at a fixed point in the future is guaranteed, usually the face value of the bond when issued.
If a company runs into financial trouble, bondholders do rank ahead of equity holders for repayment.
Bonds are bought and sold. So if a ten—year £1000 bond paying 5% (a fixed £50 a year) rises in price to £1250, the new buyer will only be getting a 4% yield on his £50 a year return, as well as only the face value of the bond on maturity.
If the price falls, the new buyer is in the money with a better yield and a capital profit on maturity.
Investing in property
Investing in property usually means investing indirectly through a fund in assets such as office blocks, shopping malls, warehouses, and business parks, rather than residential properties. The properties produce a return from their rental income, and they may also grow in capital value. Property is like equities in that it has strong potential for growth, and like bonds in that it promises a reliable income. But it can also be volatile, depending on the state of the property market and the economic cycle.
Managers will often try to grow capital and rental values by investing in tired or rundown assets, and upgrading them for new markets.
They will also try to anticipate economic trends, which may boost or depress certain types of asset such as West End offices or regional high street malls.
In a downturn, it is not always easy to sell property quickly and open—ended funds may have to sell assets at depressed prices, or suspend withdrawals from the fund. Investment trusts, however, are not subject to the same pressures and can wait for prices to recover.
Investors can also gain exposure to UK or overseas property through exchange traded funds (ETFs). These do not invest directly in property but track the value of property investment vehicles or companies.
You can use IG’s ETF screener to find property ETFs
Peer—to—peer lending platforms now use the residential and commercial property markets to offer attractive returns to individual lenders, though the risks are as yet untested in a downturn.
Investing in commodities
There are a huge number of commodities traded on global markets. For investors, one of the attractions is that they behave differently from other asset classes, and can help protect a portfolio against inflation.
Faster inflation lowers the value of future cash flows paid by both stocks and bonds, but commodities are ‘real’ assets as opposed to financial assets, so when inflation is accelerating their prices usually rise.
Commodities are raw materials used to create the products consumers buy. They include agricultural products such as wheat and cattle, energy sources such as oil and natural gas, and metals such as gold, silver and aluminium. There are also ‘soft’ commodities, which are more perishable, such as sugar, cotton, cocoa and coffee. Their prices are linked not only to demand but to fundamental supply factors which can include weather, crop failure, or geopolitical instability.
Commodities have evolved as an asset class with the development of futures indices, which reflect price expectations, and investment vehicles that track them. ETFs, for instance, cover a wide spectrum from single commodity exposure to sector based and broader based commodity exposure.
Between 1970 and 2015, annual returns from commodities had a high correlation with the US consumer price index, but a very low one with both US equities and global bonds, according to the Bloomberg Commodity Index. This tracks the futures price of 22 different commodities within seven categories