[Challenge Bond Ant] ① This Year’s Bond Investment Weather Forecast: ‘Clear’

High Interest Rates, Stock Market Slump, Tax Benefits Favor Bonds
Individual Investors' Net Bond Purchases Reach 1.08 Trillion Won This Year
Recent Interest Rate Decline... Growing Interest in Short-Term High-Interest Bonds

[Asia Economy Reporter Hwang Yoon-joo] Following last year, the environment favorable for bond investment is expected to continue this year. First, interest rates remain relatively high. Due to concerns about an economic recession, the stock market is sluggish. Tax benefits are also being added. The taxation of financial investment income has been postponed until 2025, and investing in corporate bonds through the Individual Savings Account (ISA) also offers tax-exempt benefits. Compared to stocks and virtual assets, bonds are relatively safer while allowing investors to expect both interest income and capital gains.

As a result, the so-called 'bond ants' are increasing in number. The net purchase volume of bonds by individuals, which was 4.5675 trillion KRW in 2021, surged by 351.2% to 20.6113 trillion KRW last year. The enthusiasm has continued into the new year. Bond ants purchased bonds worth 1.2315 trillion KRW from January 1 to 13.

Interest Income + Capital Gains + Tax Benefits

While the keyword for bond investment last year was 'safe assets,' this year it can be summarized as 'interest rates' and 'tax benefits.' High interest rates are likely to be maintained through this year, but rates may gradually decline starting next year. This is why many bond ants flocked to long-term bonds in the fourth quarter of last year. Interest rates and bond prices move inversely. When interest rates rise (fall), bond prices fall (rise). Bond ants who purchased long-term bonds in the fourth quarter of last year aimed to buy when bond prices were low and sell when prices rose. However, since interest rates have fallen faster than expected this year, it is necessary to respond by focusing more on short-term bonds rather than chasing long-term bonds.

Tax benefits can also be expected. With the postponement of financial investment income tax, capital gains can be fully enjoyed until 2025. Additionally, the government has decided to grant tax-exempt benefits for corporate bond investments through ISA starting this year, which is expected to increase the attractiveness of corporate bonds.

According to the Korea Financial Investment Association on the 16th, individuals have net purchased bonds worth a total of 1.2315 trillion KRW in the over-the-counter bond market from the beginning of this year to the 13th. The bonds most purchased by bond ants this month were other financial bonds such as commercial paper and capital bonds (472.8 billion KRW), corporate bonds (397.9 billion KRW), and government bonds (194.2 billion KRW), in that order.

Lee Han-gu, a bond specialist at the Korea Financial Investment Association, explained, "Since the second half of last year, demand has concentrated on relatively safe financial holding company-affiliated card bonds and capital bonds with high interest rates, as well as corporate bonds with high credit ratings."

The shift of funds into bonds began in earnest in the second half of last year. The U.S. Federal Reserve (Fed) unusually implemented four consecutive 'giant steps' (raising the benchmark interest rate by 0.75 percentage points at once), increasing stock market volatility. Moreover, interest rates were already high at that time, so funds flowed into safe assets.

The total amount of bonds purchased by bond ants last year reached 20.6113 trillion KRW. This was a record high, sharply increasing from 4.5675 trillion KRW in 2021. This was understandable as the KOSPI index fell by more than 25% over the year. Due to this, stock trading volume also halved from 20 trillion KRW at the end of 2021 to the 10 trillion KRW level at the beginning of this year.

Investors who purchased many long-term bonds at the end of last year are likely to enjoy both high interest rates (coupon rates) and capital gains simultaneously. A securities company official said, "Although the U.S. and others will not immediately stop raising interest rates and switch to cuts, the rate hikes will be limited," adding, "Expectations for a slowdown in the pace of rate hikes have increased, creating an environment where both interest and capital gains can be targeted simultaneously."

Interest Rates Falling Rapidly, Be Cautious About Chasing Long-Term Bonds

However, bond ants looking to buy long-term bonds now need to be cautious. Interest rates have fallen somewhat rapidly this year. A securities company bond manager said, "Generally, the range of interest rate fluctuations over a quarter or a year is about 80 basis points (1bp = 0.01 percentage points), but in the past few days, rates have dropped by 30 to 40 basis points," adding, "When bond interest rates fall or rise sharply, chasing purchases should be approached cautiously."

Although the attractiveness of bond interest rates has somewhat decreased compared to last year, tax benefits have increased. The government announced in the '2023 Economic Policy Direction' that ISA tax-exempt benefits will include corporate bonds and others. The financial authorities plan to revise the enforcement decree and implement this as soon as possible.

ISA is an account that allows management of various financial products such as deposits, funds, and listed stocks all at once. Currently, tax exemption applies up to 2 million KRW, and amounts exceeding this are subject to separate taxation at a 9.9% rate. Going forward, investing in corporate bonds through ISA accounts will also receive tax-exempt benefits. A Financial Services Commission official explained, "This is a measure to resolve supply-demand imbalances in the bond market," adding, "We reflected investors' long-standing requests to include bonds in ISA accounts eligible for tax exemption in the policy."

Tax benefits will also be available for high-yield funds. High-yield funds are funds that invest at least 60% in domestic asset-based bonds and at least 45% in bonds rated BBB+ or lower. These funds were created to promote investment in low-credit rating (BBB+) bonds. Although the risk is relatively high, the interest rates are much higher than those of high-grade bonds.

Additionally, the postponement of financial investment income tax collection decided at the end of last year is another factor attracting attention to bond investment. The financial investment income tax was to impose capital gains tax on bond investments as well. If capital gains occurred, a 22% tax rate was to be applied in the 2.5 million to 300 million KRW range, and 27.5% for amounts exceeding 300 million KRW. This raised concerns that bond investment sentiment would be dampened.

With the postponement of financial investment income tax collection, these worries have disappeared. Under current tax law, individuals only pay 15.4% interest income tax on bond investments. There is no tax on trading gains. If long-term bonds are purchased in advance and sold years later when interest rates fall and bond prices rise, investors pay tax only on bond interest and can fully enjoy capital gains.

Careful Observation of Domestic and International Interest Rate Movements Needed

Of course, bond investment is not always safe. Interest rates are the biggest variable. Last year, stock and virtual asset investors were disappointed as expectations about the Fed's interest rate policy were off. Caution is also necessary when investing in bonds. Opinions differ on the direction of interest rates amid signs of easing inflation. Fed Chair Jerome Powell maintains a stance of continuing to raise rates, but Wall Street analysts do not believe this. Domestic investors also believe the rate hikes have ended. Lee Chang-yong, Governor of the Bank of Korea, has shown tolerance for the inversion phenomenon where government bond yields fall below the benchmark interest rate. Typically, during the final stages of tightening perceived by the market, the 3-year government bond yield is lower than the benchmark rate.

However, some say it is premature to bet on one side. Kim Ji-man, a researcher at Samsung Securities, advised, "The market seems to be betting on falling interest rates, but it is questionable whether this will actually happen," adding, "Caution is needed when purchasing long-term bonds." Instead, he recommended focusing on short-term high-interest bonds for safety for the time being. He advised setting investment positions once the direction becomes clearer after the U.S. Federal Open Market Committee (FOMC) meeting in February.