Thrive. Grow. Achieve.

Are Bonds Safe? - What your Board Needs to Know about Interest Rate Expectations and Bond Prices

Mark Murphy, CFA Dennis Gogarty, CFP®, AIF®

Copyright Raffa Wealth Management, LLC All Rights Reserved

Are Bonds Safe? Page

DISCLAIMER

2

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product referenced directly or indirectly in this report, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your nonprofit’s portfolio. Moreover, you should not assume that any discussion or information contained in this report serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC or from any other investment professional. To the extent that you have any questions regarding the applicability of any specific issue discussed above to your nonprofit’s unique situation, you are encouraged to consult with Raffa Wealth Management, LLC or the professional advisor of your choosing.

Are Bonds Safe? Page

A SNAPSHOT OF RAFFA WEALTH MANAGEMENT

3

Portfolio Mngt for

Nonprofits

401(k) & 403(b)

Consulting

Nonprofit Policy

Consulting

$570 AUM & 66

Nonprofit Clients*

Acts as Fiduciary

Study on Nonprofit Investing (SONI)

*AUM and NP Clients as of 12/31/2015

@ RaffaWealthMngt

Are Bonds Safe? Page

THE STUDY ON NONPROFIT INVESTING (SONI)

4

•Peer benchmarking survey

•Last year, over 700 nonprofits participated

•Helps to answer – How do other nonprofits invest their reserves? – Are our investment policies “normal”? – Is our investment performance in-line with

similar organizations?

•FREE results report

•Visit www.npinvesting.org to see last year’s Executive Summary

Participate today! Deadline is Tuesday, Feb. 28 https://www.surveymonkey.com/r/2017SONISurvey_116

@SONIstudy

Are Bonds Safe? Page

AGENDA

5

• How do interest rates effect bond prices?

• Are bonds safe?

• How do you know if your bonds are safe?

• What is the likely future direction of US interest rates and the resulting impact on bond prices?

• Is owning bonds through bond mutual funds less safe?

• How to use your investment policy to manage bond safety.

• Performance reporting and policy compliance – particularly related to bonds

Are Bonds Safe? Page

HOW DOES BOND VALUATION WORK

6

The price of a bond is the present value of all cash flows generated by the bond (coupon and face value) discounted at the required rate of return.

Are Bonds Safe? Page

HOW DO INTEREST RATES EFFECT BOND PRICES?

7

Example of how a bond is priced:

-First issued – in line with market rates -10 year bond, fixed rate 5% coupon

-If interest rates move to 6%

-If interest rates move to 4%

When interest rates rise bonds prices fall and when interest rates fall bond prices rise.

Are Bonds Safe? Page

HOW DOES BOND VALUATION WORK

8

Factors that drive change in bond prices:

-Inflation expectations

-Credit quality

-Maturity/duration

-Financial news

-Monetary/fiscal policy

Are Bonds Safe? Page

ARE BONDS SAFE?

9

-It depends what you are comparing them to.

-On average negative returns from bonds every 6 years vs. stocks every 4 years.

For Illustration purposes only. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.

Are Bonds Safe? Page

HOW DO YOU KNOW IF YOUR BONDS ARE SAFE?

10

-Credit rating

For Illustration purposes only. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.

Are Bonds Safe? Page

HOW DO YOU KNOW IF YOUR BONDS ARE SAFE?

11

-Duration - measure of the approximate sensitivity of the price of a bond to a change in interest rates.

Starting Yield = 2.3% Duration = 5.6 years

Source: Vanguard

For Illustration purposes only. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.

Are Bonds Safe? Page

HOW DO YOU KNOW IF YOUR BONDS ARE SAFE?

12

-Diversification (no sector or geographic concentration)

Are Bonds Safe? Page

WHAT IS THE LIKELY FUTURE DIRECTION OF US INTEREST RATES

13

Source: Federal Reserve Board of Governors -Fed says expects to raise Fed Funds rate three

times this year

-Said this last year - raised once

-A large shock to the markets or weaker economic data could drive rates down again

Are Bonds Safe? Page

IMPACT ON BOND PRICES

14

-Likely that US interest rates will rise over longer term.

-Speed of interest rate increase -Still serve important roll in portfolio -Unlikely to time interest rates -Maintain shorter maturity -Investors with time horizon longer than duration of their bonds in better shape

Are Bonds Safe? Page

IS OWNING BONDS THROUGH BOND MUTUAL FUNDS LESS SAFE?

15

Owning bonds through bond funds can be just as safe as owning individual bonds – just a different structure

Pros: -Diversification -Ease of investment/timeliness -Greater efficiency -Dividend reinvestment -Can maintain targeted characteristics more easily -Liquid

Cons: -Not as customizable -Exact interest payments and future value unknown -Heavy outflows by investors

Are Bonds Safe? Page

HOW TO USE INVESTMENT POLICY TO MANAGE BOND SAFETY

16

-Credit quality

-Average maturity/duration

-Diversification

-Reporting requirements

Are Bonds Safe? Page

PERFORMANCE REPORTING AND POLICY COMPLIANCE – PARTICULARLY RELATED TO BONDS

17

-Ask that your advisor include a statement or statistics comparing what is in the IPS to how the bond investments sit currently.

Are Bonds Safe? Page

CONCLUSION

18

• When interest rates rise bond prices fall and when interest rates fall bond prices rise.

• Over the long term interest rates are likely to increase, however the pace of increase determines the degree of impact.

• Bonds are generally much safer than equities.

• Review your portfolio’s credit quality, maturity/duration and diversification to determine how safe you portfolio is.

• Owning bonds through bond mutual funds is just as safe as owning individual bonds assuming the mutual fund meets several standards.

• Include credit quality, average maturity/duration, diversification and reporting requirements in your investment policy to manage bond safety. Require your investment advisor to compare the bond portfolio vs. the policy requirement in reports to confirm compliance.

Are Bonds Safe? Page

WHAT’S YOUR ACTION?

19

• We have provided a document outlining six questions a non profit should verify in their Investment Policy Statement (IPS) – review this and confirm IPS addresses these issues.

• If there is uncertainty about your organization's fixed income investments – we can help.

• Please participate in the 2017 SONI survey.