Hi, I have some questions on the Singapore Bond fund to strengthen my understanding of it.
Firstly, I understand that the underlying assets of A35 are Singapore govt bonds. When these bonds reach maturity the find manager just uses this money to buy new bonds.
1) So why does the NAV/Intraday NAV listed on the nikkoam website change daily? Is it because everyday some bonds reach maturity and the fund manager buys a lower/higher value bond?
In order words, how does the value of the bond fund change?
The NAV reflects the market price of the bonds that are in the portfolio. SGS trade in an active market, like any other bond, or like a stock.
If there's lots of demand to buy Singapore government bonds, their price goes up, so the fund's NAV goes up. It's the same as for an equity ETF.
2) How is the price of the bond fund increasing steadily over the years? Is it solely due to the yield paid out by the underlying Singapore bonds? How does the fund pay out dividends then?
It's been pretty much flat since 2012 - which is what you want from a bond fund. You want it to be a nice stable place to park your cash and earn better-than-bank-interest.
From 2008 to 2012, it moved pretty steadily higher; the reason for that is that interest rates collapsed after the GFC, so the price of the bonds that the fund was holding rocketed higher.
3) Is it possible for the fund to be overvalued or undervalued? Currently it is trading tightly within 1 cent difference. Is it possible for the fund to trade well above or well below NAV?
Sure, this can happen, though it's extremely rare.
There are market-makers active in A35 that trade the ETF against the basket of bonds underlying it. If A35 gets expensive compared to its NAV, they can buy the bonds that make up A35's portfolio, in the right proportions; deliver those to Nikko; and get (relatively expensive) shares of A35 in return. Then they can sell those shares, for more than they paid for the bonds.
Conversely, if A35 trades cheap, they can buy shares of A35, crack them open for the bonds (in practice, this involves handing the shares back to Nikko and saying "bonds plzkthx"), and then sell the bonds for more than they paid to buy the A35.
If the market makers step out of the market, maybe because the market is exceptionally volatile or just because the computers are tired and want a snooze, then there won't be an active arbitrageur between the stock price and its NAV. In that case, yep, it can swing away from its NAV, but:
1) It'll come back when the arbitrageurs come back; and,
2) You might be able to sell high or buy low if you're rebalancing in the meantime.
Next question will be why will the bond price be negatively correlated with the stock market, assuming there will be no external reasons causing a stock market crash.
This is just "one of those things". Think of it as a flow thing: when stocks go down, people flood into bonds because they're a "safe haven". When stocks go up, people flood from bonds into stocks because they want to ride the wave.
If the government raises interest rates, then stock prices will generally fall as people will opt for safer options with higher interest rates. But that will mean that the bond NAV will fall too right since the new bonds issued will have a higher interest rate?
The bond NAV will fall, but stock prices won't necessarily fall.
Intuitively, it might make sense to think "interest rates go up, therefore the discount rate applied to stock earnings should go up, therefore the price should go down". But what happens in practice is that interest rates tend to go up because central banks hike short rates; and central banks tend to hike short rates because the economy's doing well. And when an economy's doing well, stocks tend to go up.
This paper from TIAA, a big investment group in the USA, digs a little deeper. They argue that the correlation swings from negative to positive and back, but also (page 5), they note that equity valuations tend to rise as economies recover. That's what we've seen in the USA over the last few years: higher stock valuations even though interest rates have risen.
Bbcwatcher, the main factor why bond fund increases steadily is easy to answer. Basically a bond's price has 2 components, the principal and the accrued interest. On a daily basis, assuming interest rate doesn't change, the bond price goes up by the amount of interest accrued for the day. It is called as clean price and dirty price. Clean price is just the principal and dirty price is principal + interest accrued. On the date of coupon payment, the bond price falls because the coupon gets paid out, similar to dividend paid out by shares.
So there's a nuance here.
The bonds underneath the ETF can be traded clean or dirty, but the bond ETF itself is always priced on a dirty basis, like any other stock. Whenever one of the underlying bonds pays a coupon, or redeems, the fund will just take that money and add it to its value, and then pay it out as a dividend at the end of the year.
Accrued interest gives the fund's price a sawtooth pattern. All other things being equal, it ticks up over the course of a year as the bonds in the fund pay their coupons, then it gaps down on the day the dividend gets paid.
