Bonds: An Affordable Asset Class

Investment basics on an increasingly popular asset class for retail investors

Issue: Jan 2012

Corporate bonds have become increasingly affordable and popular among retail investors
Corporate bonds have become increasingly affordable and popular among retail investors

Corporate bonds, typically issued in denominations of hundreds of thousands of dollars and largely the domain of institutional investors or sophisticated investors, are now within the reach of the typical man in the street. Thanks to the recent spate of successful corporate bond issuances in Singapore targeted at the retail investors, retail investors are now able to invest directly into this asset class with just a few thousand dollars.

Corporate bonds are issued by companies seeking to raise funds for the purposes of funding expansion plans or acquisitions, capital expenditure or boosting the company's balance sheet. While corporate bonds may carry a higher risk than fixed deposits, they often pay a higher yield. In today's environment where saving rates are at record lows and are expected to stay low in the next few years amid a challenging economic climate, corporate bonds can be especially attractive for investors seeking higher returns for their funds. It is therefore no surprise that recent bond issues from reputable blue-chip companies in Singapore have seen keen interest.

In January 2011, CapitaMalls Asia (CMA) Treasury Limited issued a 1-year bond paying 1% coupon and
3-year bond paying 2.15% p.a. coupon in Singapore, targeted at retail investors. The combined public tranche was 1.8 times oversubscribed. CapitaMall Trust also followed suit shortly and issued a 2-year bond paying 2% p.a. coupon shortly after and likewise meet with strong demand. Apart from CMA Treasury and CMT issues, there have been other corporate bond issues in Singapore targeted at retail investors. Singapore Airline's October 2010 offer and Fraser & Neave's March 2011 offer were also met with overwhelming response.

CapitaMalls Asia's retail bond issuance in January 2011 was 1.8 times oversubscribed
CapitaMalls Asia's retail bond issuance in January 2011 was
1.8 times oversubscribed

"We were pleasantly surprised by the strong demand given it was our inaugural issue of retail bonds and CapitaMalls Asia was only listed in end 2009. The coupons we offered were win-win for our shareholders as well as the bond holders. The company gets access to a new source of debt at competitive pricing and bond holders get access to fixed income bonds at an affordable entry price. Overall, for 2011, bonds actually outperformed equity and hopefully, through this experience, investors can appreciate the nature of retail bonds and make them a critical part of their portfolio," said Mr Ng Kok Siong, Chief Financial Officer of CapitaMalls Asia.

What Are Bonds?

Bonds are fixed income assets. They provide a fixed income stream at regular intervals plus a repayment of the principal at maturity. As the investor will get the principal back at maturity, bonds can be a good vehicle to preserve capital. At the same time, the investor can earn a higher return than fixed deposits. As their value tends to be inversely correlated with equities, they can be viewed as a means of diversification for an investor's portfolio. They are also generally less volatile than equities. Bonds, unlike property investment are also less likely to be subject to regulatory measures. This is true in an environment where the government has recently announced measures to cool down residential property prices. In times of heightened uncertainty and volatility in global markets, many savvy investors have sought to anchor some stability of their investment portfolio by moving into less risky investments such as bonds. Retail investors who consider corporate bonds as a core allocation in their portfolio should look out for CMA's upcoming bond issue in early 2012.

Below are some investment basics to note about bond investment:

Bonds can be a good vehicle to preserve capital
Bonds can be a good vehicle to preserve capital
  • Debt Instrument: A bond is a debt security. It is like an IOU. When an investor buys bonds, he/she is lending money to the issuer. The investor becomes the lender or bond holder and the issuer becomes the borrower.
  • Fixed, regular income: The investor will receive interest payments from the issuer. These interest payments are contractual obligations from the issuer. They provide a predictable stream of income on a set schedule to the investor.
  • Diversification: By holding some bonds, the investor can diversify his/her portfolio, especially in times of high volatility and economic uncertainty. As a rule of thumb, bonds and stock prices generally move in opposite directions. Diversification does not insure against losses, but it can reduce the overall volatility and risk of one's portfolio.
  • Insure against deflation: As most bonds pay a fixed coupon which does not change, the investor can buy more goods and services with the same bond income if there is deflation.
  • Liquidity/Marketability: If the investor needs cash, he/she can sell the bonds in the secondary market at any time after the issue prior to maturity.
  • Capital Protection: Bond holders receive the principal upon maturity and this serves as a tool for endowment and savings for future commitments and expenses like children's education, payment towards a car and/or a home.

What Are The Risks Involved?

Bonds in general may be relatively safer than equities, but they are not without risks.

Like all investments, bonds are not without risks although they are generally safer than equities
Like all investments, bonds are not without risks although they are generally safer than equities
  • Credit risk: There is a possibility that the issuer can go bankrupt. As a result, the issuer may default on coupon payments or even the principal when the bond matures. It is therefore important to assess the credit-worthiness of the bond-issuing entity. Is the issuer's business profitable? Does the issuer have the financial strength to pay the coupons and principal? Is the issuer a reputable company with a good track record? Who are the immediate and ultimate shareholders of the company?
  • Inflation risk: Bonds generally lack protection from inflation. Inflation causes tomorrow's dollar to be worth less than today's. In other words, it affects the real value of the principal and interest payments you receive.
  • Event risk: If the issuer undertakes a leveraged buyout, debt restructuring, merger or recapitalization that increases its debt load, the value of its bonds may be affected.

If the investor decides to trade the bonds prior to maturity, there are some factors that can have an impact on prices:

  • Interest rate risk: Bond prices and interest rates have an inverse relationship. When interest rates rise, bond prices fall and vice versa. The price of existing bonds tends to fall when interest rates rise because new bond issues that come into the market will have higher yields (to reflect higher market interest rates). This means the price of an existing bond will have to be adjusted downwards so that its yield will be comparable to the market rate. The reverse is true.
  • Liquidity risk: Bonds are generally the most liquid during the period right after issuance when the typical bond has the highest trading volume. A bond that is thinly trading in the secondary market may be subject to a liquidity discount.
Bonds can provide the cornerstone to a well diversified and balanced portfolio
Bonds can provide the cornerstone to a well diversified and balanced portfolio

In summary, bonds can provide the cornerstone to a well diversified and balanced portfolio. They give a predictable stream of income, provide a higher yield than fixed deposits, return the principal at maturity and provide diversification for an equity portfolio. And with many companies now issuing bonds at denominations that cater to the retail investors, the man in the street can now directly invest into bonds. It is, therefore, no surprise that the retail investors have rapidly warmed up to this asset class.


Article is contributed by Christopher Wong, Manager of Economics Unit, CapitaLand Limited.

Comments
User gary
203.127.116.X | 2012-02-23 12:55:13
good
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