I have finished reading Larry’s bond book that I bought more than a month ago. Larry wrote that currency-hedged foreign bonds provide the benefit of diversification of interest rate risk. However, no suggested allocation was given. Indexfundfan’s Foreign bond allocation for Singapore investors suggests a 50:50 allocation to foreign bonds and Singapore bonds. This sounds good to me. I think I will start with this allocation.
Next, where is the “sweet spot” (the point where the yield curve is no longer upward sloping) of Singapore Government Securities (SGS) yield curve? Below is the SGS weekly yield curve for 1-year T-bill and 2, 5, 7-year bond since 1998.
In the recent year, the yield curves of different maturity have converged, so the “sweet spot” has shifted to the shorter maturity end. Was it worth to extend the maturity of SGS bonds and take the interest rate risk in the past? Lacking any rule of thumb, I use Larry’s suggestion of 0.2% minimum incremental yield for each additional year of maturity. So the question becomes: when extending the maturity of SGS, how many occurrences since 1998 satisfied the minimum incremental yield requirement?
Below is the yield spread for extending SGS maturity from 1 to 2 years, 2 to 5 years and 5 to 7 years. The horizontal lines are the minimum incremental yield requirements for the respective extensions (as indicated by the colour). For example, the yellow line represents 0.4% (0.2%X2) minimum incremental yield requirement for extending SGS maturity from 5 to 7 years. More dots above the line means more occurrences that meet the requirement. As you can see, extending SGS maturity from 1 to 2 years and 2 to 5 years have a higher chance of meeting the requirement than extending SGS maturity from 5 to 7 years. I did not include extension from 7 to 10 and 10 to 15 years because the were negligible number of occurrences that satisfied the minimum incremental yield requirement.
So from the historical SGS yield curve, I think it is worth to extend the maturity of individual bond to 7 years for my bond ladder, provided the minimum incremental yield requirement is met.