Bonds 101: Understanding Yield & Duration

Hello investors!

Today, I'd like to delve deep into a topic that, while not as glamorous as stocks, is equally significant in our financial world: Bonds. Specifically, we'll tackle the concepts of 'Yield' and 'Duration'. Warren Buffett, the Oracle of Omaha, once quipped, "If stocks are the glamorous celebrities of the finance world, then bonds are its unsung heroes." And he's right. Let's take a closer look.

In todays letter

• Learning: Bonds 101: Understanding Yield & Duration

• News insights

  • NZ Trims Budget Amid Economic Slump

  • Top-tier Recycling Boosts Circular Economy

  • NAB Axes 10% of Market Jobs, says AFR

• Key takeaways from interview w/ Josh Young

Bonds 101: Understanding Yield & Duration

A bond is essentially a loan that an investor provides to an issuer, usually a corporation or government. In return, the issuer agrees to pay periodic interest payments, known as the yield, until a predetermined date, at which point they return the principal amount. The time taken to return the principal is known as the bond's duration.

For instance, imagine lending $1,000 to a corporation with a 5-year bond at a yield (interest rate) of 5%. Every year, for 5 years, you'd receive $50 (5% of $1,000). At the end of the 5 years, you'd get back your original $1,000.

Five Essential Points about Bonds:

1. Risk and Reward: Just like stocks, bonds carry risk. Government bonds, especially those of economically stable countries, are considered low-risk, while corporate bonds carry varying degrees of risk.

2. Price and Interest Rate Relationship: The price of a bond is inversely related to prevailing interest rates. When interest rates rise, bond prices fall and vice-versa. Charlie Munger often stresses the importance of understanding this relationship.

3. Duration: Duration measures the sensitivity of a bond's price to changes in interest rates. The longer the duration, the more sensitive it is to rate changes.

4. Creditworthiness: This is crucial. The likelihood that the bond issuer will be able to make all interest payments and return the principal at maturity depends on their financial health.

5. Diversification: Don’t put all your eggs in one basket. As with all investments, diversifying across different types of bonds can reduce risk.

Case Study: In 2002, investors flocked to purchase bonds issued by a well-known tech company. Attractive yields and the firm's strong reputation made it seem like a no-brainer. But as the tech bubble burst, the company faced severe financial distress. Investors who'd diversified their bond holdings felt the pinch but were protected from massive losses. Those who'd heavily leaned into this one bond faced significant losses, underscoring the importance of diversification and creditworthiness assessment.

The bottom line

Understanding bonds, their yields, and duration is crucial for any diversified investment strategy. As the legends of value investing like Buffett and Munger emphasize, knowledge, patience, and diversification are key. Bonds might not make headlines as frequently as stocks, but they play a pivotal role in balancing our portfolios and ensuring consistent returns.

News insights

NZ Trims Budget Amid Economic Slump

New Zealand's government, grappling with a domestic recession and concerns over China's slowing economy, plans to cut spending. The government has identified nearly NZ$4 billion in potential savings over the next four years, targeting reductions in consultant and contractor expenditures, among other areas.

[📝Full article]

Key takeaway

The New Zealand economy is feeling the pinch from both domestic pressures and international economic challenges, particularly China's economic slowdown. Investors should monitor the situation closely for its impact on sectors reliant on Chinese demand, like commodities, while also being aware of the government's tightened fiscal stance as they assess investment opportunities in New Zealand.

Top-tier Recycling Boosts Circular Economy

Fibre-based packaging demonstrates one of the highest-quality recycling systems in Europe, allowing recycling from any type of packaging to another. However, the main obstacle lies in streamlining the separate collection of paper for recycling throughout the continent.

[📝Full article]

Key takeaway

This article underscores the importance of fibre-based materials as a sustainable choice for packaging and emphasizes the potential to increase the already impressive recycling rate in Europe. Investors should closely monitor companies and technologies in the fibre-based packaging and recycling sectors as the demand for sustainable packaging solutions is likely to rise, and governments are urged to streamline and enhance recycling infrastructure.

NAB Axes 10% of Market Jobs, says AFR

The National Australia Bank (NAB) is set to reduce its workforce in the markets division by approximately 10%, equivalent to 60 out of 600 jobs, as part of a larger restructuring move, according to the Australian Financial Review. This decision follows similar job cut actions by Commonwealth Bank of Australia and Westpac Banking Corp, who are looking to curb rising costs in the face of high interest rates and inflation.

[📝Full article]

Key takeaway

This news signals a broader trend among major Australian banks to manage their operational costs amid a challenging economic landscape characterized by high interest rates and inflation. For investors, it suggests a possible focus on efficiency and restructuring within the banking sector; they might consider closely monitoring the financial performance and strategic moves of these banks in the coming quarters.

Key takeaways from interview w/ Josh Young

Here are five key takeaways from the video:

1. Buffett's Positioning in the Oil and Gas Sector: Warren Buffett has been adjusting his stakes in the oil and gas sector. He has been selling some of his Chevron shares while buying more of Occidental Petroleum (Oxy). This suggests that Buffett is bullish on the price of oil and the value of oil-producing assets but may be less optimistic about refining, given his reduced stake in Chevron, which has significant exposure to refining.

2. Oil Market Dynamics: The oil market has seen significant fluctuations. Factors influencing these changes include Russia's consistent supply to the market, China's reopening affecting demand, and OPEC's supply cuts. Despite some negative surprises, OPEC's supply cuts have brought the market back into a deficit, leading to rising oil prices.

3. Berkshire's Investments in the Energy Sector: Berkshire Hathaway's investments in the energy sector are noteworthy. They have substantial stakes in Chevron and Occidental, with the energy sector being one of the cheapest sectors currently. Berkshire also plans to invest in a liquefied natural gas export terminal in Maryland and is pushing for a bill in Texas related to natural gas-fired power plants.

4. Natural Gas Volatility: The natural gas market has seen significant volatility, with prices ranging from close to ten dollars in 2022 to around two dollars and sixty cents now. Factors influencing this volatility include the productivity of shale gas in the US, associated gas from shale oil activity, and various market dynamics.

5. OPEC's Concerns: OPEC has been vocal about the underinvestment in oil. They have been making production cuts and have expressed concerns about the future of the oil market. Their stance and actions play a crucial role in influencing global oil prices.

[🎥Full video]

That’s all for today, thank you for reading. Till the next time!