How to Profit from Bonds: Strategies for Conservative Investors
1. Choosing Types of Bonds
1.1. Government Bonds (OFZ)
Federal loan bonds (OFZ) are issued by the Ministry of Finance of the Russian Federation and are considered virtually risk-free, as the state guarantees their redemption. The yield on OFZ typically ranges from 6–8% per annum and can either be floating, linked to the key interest rate, or fixed. The liquidity of these securities is very high: average daily trading volumes exceed 30 billion RUB, allowing for swift entry and exit from positions with minimal costs.
1.2. Investment-Grade Corporate Bonds
Corporate bonds from large companies—'blue chips'—such as Sberbank, Gazprom, Lukoil, and Norilsk Nickel, have ratings of ruAA–ruA (AKRA) and BBB– or higher (S&P). Their coupons yield between 8–10% per annum, with liquidity varying from average to high. For conservative investors, it is recommended to select bonds with a rating of no lower than ruA to minimise default risk and ensure stable income.
1.3. Bank Issues
Systemically important banks, such as Sberbank and VTB, issue bonds with a ruAA rating and yields of 7–8%. Tinkoff Bank offers coupons of up to 9.5% with a ruBBB rating, which reflects a higher risk. Bank issues provide additional diversification and often boast good liquidity due to trading volumes and state support measures for the banking system.
1.4. Municipal Bonds
Municipal bonds issued by regions and major cities (such as Moscow, Moscow Region, and St. Petersburg) offer coupons of 7–9% and ratings of ruA–ruBBB. Although these securities have lower liquidity compared to OFZ, they are suitable for diversification and enhancing returns without excessive risk, provided that the holder carefully assesses the financial position of the region and its track record of fulfilling obligations.
2. Calculating Bond Yield
2.1. Coupon Yield
Coupon yield is calculated as the ratio of the annual coupon to the nominal value. This is the simplest and most straightforward indicator of a bond's performance. However, it does not account for any premium or discount upon purchase.
2.2. Yield to Maturity (YTM)
YTM reflects the total expected return of a bond if held to maturity, including all coupons and the difference between the purchase price and the nominal value. YTM is a convenient tool for comparing different issues, regardless of their coupon rates and current market prices.
2.3. Real Yield
Real yield adjusts for inflation: real income = YTM – inflation. With a YTM of 8% and inflation of 5%, the real income would be approximately 3%. OFZ with a floating coupon help automatically offset inflation, while corporate bonds require inflation forecasts to assess real profit.
3. Risk Management
3.1. Credit Risk and Ratings
Credit risk is associated with the likelihood of default by the issuer. OFZ are free from this risk; for corporate bonds, critical ratings from Moody’s, S&P, AKRA, and Expert RA come into play. Investors should focus on securities with a rating of no lower than BBB–/ruA to mitigate the risk of coupon and principal non-payment.
3.2. Interest Rate Risk and Duration
Duration indicates how much the price of the bond will change with a 1% movement in interest rates. For securities with maturities of up to three years, the duration usually does not exceed two years, which reduces interest rate risk. Long-term issues (7–10 years) may lose up to 7% in value with a 1 percentage point increase in rates, hence their share in the portfolio should be limited.
3.3. Liquidity and the Secondary Market
Liquid issues can be easily bought and sold with a narrow spread. OFZ and large corporate bonds exhibit high liquidity: orders are executed instantly, and spreads typically do not exceed 0.01–0.05%. Lesser issues require caution due to wide spreads and low trading volumes.
4. Diversification and Rebalancing
4.1. Optimal Portfolio Structure
For conservative investors, the recommended structure is: 50% OFZ, 30% high-rated corporate bonds (ruAA–ruA), 15% bank issues ruAA, and 5% municipal bonds. This diversification mitigates sector and interest rate risks.
4.2. Portfolio Rebalancing
Rebalance every 3–6 months: return asset shares to target values by selling appreciated securities and buying underrepresented ones. This allows for profit-taking and maintains the desired level of risk.
4.3. Building a Liquidity Fund
Keep 5–10% of funds in highly liquid OFZ or short-term issues with a duration of up to one year. This ensures prompt access to funds when advantageous opportunities arise or unexpected expenses occur.
5. Tax Optimisation via IIS
5.1. Tax Deductions
The IIS with deduction type A exempts the investor from paying 13% income tax on coupon income. This increases the effective yield on bonds by 13%, making OFZ and corporate bonds more appealing for long-term investors.
5.2. Limits and Conditions
The investment limit for IIS is 1 million RUB per annum, with a maximum deduction of 52,000 RUB. The account must be held for at least three years: premature closure forfeits benefits, so it is important to develop a multi-year investment strategy.
5.3. Portfolio Segmentation
Allocate part of your funds (up to 1 million RUB) to the IIS to benefit from tax deductions, while keeping the remainder in a regular account. This allows for a combination of maximum yield and flexible capital management.
6. The Impact of Macroeconomics
6.1. Changes in Key Interest Rates
An increase in the key interest rate by the Central Bank leads to a decrease in bond prices, particularly long-term ones. Investors should reduce duration and switch to short-term issues (1–3 years) during periods of rising rates to minimise losses.
6.2. Inflation and Real Yields
Rising inflation diminishes the real purchasing power of coupon payments. OFZ with floating coupons help maintain real yields, while fixed corporate bonds necessitate inflation forecasts for assessing real profits.
6.3. Geopolitical and Regulatory Factors
Sanctions, regulatory changes, and fiscal policies impact the reliability of issuers and market liquidity. Diversification across issuers, sectors, and maturities helps protect against the negative effects of geopolitical shocks.
7. Investment Strategies for Conservatives
7.1. Buy-and-Hold Strategy
This is suitable for securities with high ratings and moderate coupons. The investor retains bonds until maturity, not reacting to short-term fluctuations, thus reducing emotional mistakes and trading costs.
7.2. Rollover Strategy
Upon maturity, reinvest the received funds into new issues with better conditions. This approach allows for adaptation to changing rates and helps maintain the portfolio's income level.
7.3. Hybrid Approach
Combine passive holding strategies (80% of assets) with active trading in the secondary market (20% of assets) to enhance returns while controlling risks. The active portion is invested during narrow spreads and high liquidity moments.
8. Practical Tips and Cases
8.1. Investor Mistakes
Common mistakes include concentration in a single bond, ignoring duration, neglecting tax deductions, and overlooking broker fees. Diversify your portfolio and consider all expenses when calculating yield.
8.2. Example of a Conservative Portfolio
Investor A allocated their portfolio as follows: 60% OFZ of varying maturities, 25% ruAA corporate bonds, and 15% ruAA bank issues. As rates rose, some funds were shifted to short-term OFZ, maintaining an average yield of 7% with minimal volatility.
8.3. IIS Usage Cases
Investor B invested 1 million RUB in OFZ through an IIS, receiving a deduction of 52,000 RUB and a net yield of 8.7%. Concurrently, they kept the remaining portfolio on a brokerage account, ensuring flexibility and increased diversification.
8.4. Expert Recommendations
Analysts from leading brokerage firms advise selecting no more than three high-rated issues in each category to simplify monitoring and reduce operational costs. Furthermore, they recommend staying updated on economic publications and regularly checking issuer ratings.
8.5. Action Plan for Beginners
1. Define financial goals and investment horizons. 2. Choose a reliable broker with analytical tools. 3. Construct a portfolio following the 50:30:15:5 scheme and open an IIS. 4. Set up notifications for coupon dates and rating updates. 5. Rebalance every 3–6 months to maintain target asset shares.
