Report from The Business Times (Singapore) dated Wed, Apr 20, 2011
Putting money into bonds
By Maxie Aw Yeong and Teh Shi Ning
BONDS, often viewed as the boring, lesser cousins of instruments such as shares or commodities, can in fact offer something for every investor, whether conservative or risk-taking. This week, we go over the basics of what to look out for when adding them to your investment portfolio.
In essence, bonds are IOUs - financial contracts issued by governments, companies or some other organisations looking to raise funds. Typically, the bondholder lends the bond-issuer a fixed amount of money, for a fixed time period, in exchange for regular payment - a fixed amount of interest known as the coupon. If you hold on to the bond until its maturity date, you get back what you lent originally (the principal, or bond par price). As bonds, once issued, can be traded, you can also gain by selling it at a higher price before maturity.
Why invest in bonds?
A bond is seen as a 'fixed-income' instrument because it pays a regular amount at designated intervals. Singapore Management University's Associate Professor of Finance (Practice) Joseph Lim says: 'This is advantageous for investors looking for a steady stream of income from their investments - for example, retirees.'
In comparison, the dividend income a share investor gets may not be as reliable.
The capital value of the bond - which the investor will get back in full upon maturity - is also more stable than the price of a share. In fact, if a company goes into liquidation, bondholders, like other creditors, get repaid ahead of shareholders.
Of course, this low-return stability can be a drawback, particularly for young investors with a longer investment time-horizon. SIM University's head of programme for finance Associate Professor Sundaram Janakiramanan notes, though, that with Singapore's stock market being highly volatile over the past three years, it could be wise to diversify into bonds 'that are less volatile, and provide periodic return'.
Risks?
Yes, like any investment, bonds have their risks too - the bond issuer could go bankrupt and default on payments, or inflation could erode any gains you make from investing in the bond.
Ngee Ann Polytechnic School of Business and Accountancy senior lecturer Chong Kek Weng says: 'The savvy bond investor needs to be aware of macroeconomic trends such as inflation, unemployment, GDP/GNP, international trade as well as government fiscal and monetary policies.'
This is especially so in the current low interest rate environment, says SMU's Prof Lim. 'Interest rates are now more likely to go up than down. An increase in interest rates will result in a fall in bond prices,' he says.
SIM University's Prof Sundaram, too, cautions that how the market price of the bond moves affects whether the investor gains or loses if he wishes to sell his bond before maturity. He thinks it is 'not prudent' to invest in Singapore bonds at the moment.
Bonds generally also lack protection from inflation. Inflation affects the real value of both your principal (what you get when the bond matures) and your interest payments.
Inflation has been rising, so one question to ask is whether it could be higher than the coupon rate on your bond, in which case, the money you've invested in the bond may not be growing fast enough to keep up with inflation. There are exceptions though - certain bonds have coupon payments adjusted for inflation.
Also, although bonds can appear relatively safer with their fixed payments, the possibility of default must still be factored in, says Prof Sundaram. 'There is always a chance that a bond issuer might default on their coupon payments or the principal at time of contract maturity.'
Bond investments Government bonds
# Singapore Government
Securities are issued directly by the Monetary Authority of Singapore (MAS) via primary auctions which are announced periodically. You can submit bids for these via the DBS, UOB and OCBC ATMs once MAS has announced a primary auction, if you have a valid individual securities account with The Central Depository. Or, you can buy and sell SGS on the secondary market through an agent bank.
# Corporate bonds
Corporate bonds are listed on the Singapore Exchange so to buy them you will need to use a stockbroker who can trade securities on SGX. You can then buy or sell them just as shares of listed companies are bought and sold, at the market price. This can be done online too, if you're using an online broker.
Mr Chong observes that bond issuance is rising in popularity among companies, which means investors 'can look forward to more choices and a greater variety of listed bonds in the market'.
# Bond funds
Bond funds are professionally managed funds which pool together small investors' monies to buy bonds. It can be an economical way for a young investor to access the wider range of bonds which are not as accessible to retail investors with no investment expertise and a smaller portfolio.
A managed fund also diversifies across a range of bonds to reduce investors' exposure to any single issuer's risks, with fund managers monitoring risks too. But this means that the company will take management fees and some professional charges.
# International bonds
Some banks here offer both Singapore dollar bonds and bonds in an international currency, issued by corporations or governments from around the world. 'There is an exchange rate risk involved when investing in foreign bonds,' notes Prof Sundaram.
Such an investment can be attractive as bonds issued in a high interest rate country such as Australia will have a higher yield than that of bonds issued in low interest rate Singapore. But as this requires currency conversion, it is a good proposition only as long as the Singapore dollar does not appreciate substantially.
Know your bond jargon
# Term of maturity
Generally, bonds with a shorter term have a lower coupon. Bonds with a longer term of maturity usually offer higher payouts due to a longer waiting time before the borrower gets back his money.
# Coupon payment
Different bonds offer different coupon rates. Holding other factors constant, bonds with higher coupons are more attractive due to the higher yearly payout that the bondholder receives.
# Rating
Agencies like Standard and Poor's and Moody's Investors Service issue credit ratings on bonds. A higher rating suggests the bond is safer and that the issuer is more financially credible - less in debt with a lower probability of default. A bond rated AAA or AA is considered 'high grade', while one rated BBB and above is 'investment grade'. Junk bonds are usually high-yield bonds whose issuers have a speculative credit rating that is below investment grade.
'The difference between the yields of different rated bonds, known as yield spreads, tends to increase while the economy is not doing well, and reduces when the economy is doing better,' says Prof Sundaram.
# Denomination
Bonds are usually denominated in the currency of the country in which the bonds are issued, though they can be issued in a foreign currency too. The yield on the bond is then related to the interest rate in the country whose currency it uses.
Some common types of bonds include:
# Fixed-rate bonds: These pay the same level of interest throughout the tenure of the bond, until it matures.
# Adjustable-rate bonds: The interest paid on these varies according to economic conditions. Such bonds are often pegged to an index, such as the federal funds one or an interbank rate.
# Zero-coupon bond: This type of bond does not pay interest during its life-span, and so is normally sold at a discount to its actual value. So the investor makes his gain when he resells the bond, or redeems it at full value.
# Convertible bond: This usually has a low coupon rate, but allows its holders the additional option of converting the bond into shares in the issuing company, at a certain price, typically fixed at a premium to the market price of the shares.
# Singapore Government Securities (SGS): These bonds are issued by the Singapore government, with maturities of two, five, seven, 10, 15 and 20 years. The Singapore government does not actually need to borrow money to finance its expenditure. Its issuance of SGS is more to provide a liquid investment alternative with little risk of default, and to establish a liquid government bond market to serve as a benchmark for the corporate bond market.
This article was first published in The Business Times.
Putting money into bonds
By Maxie Aw Yeong and Teh Shi Ning
BONDS, often viewed as the boring, lesser cousins of instruments such as shares or commodities, can in fact offer something for every investor, whether conservative or risk-taking. This week, we go over the basics of what to look out for when adding them to your investment portfolio.
In essence, bonds are IOUs - financial contracts issued by governments, companies or some other organisations looking to raise funds. Typically, the bondholder lends the bond-issuer a fixed amount of money, for a fixed time period, in exchange for regular payment - a fixed amount of interest known as the coupon. If you hold on to the bond until its maturity date, you get back what you lent originally (the principal, or bond par price). As bonds, once issued, can be traded, you can also gain by selling it at a higher price before maturity.
Why invest in bonds?
A bond is seen as a 'fixed-income' instrument because it pays a regular amount at designated intervals. Singapore Management University's Associate Professor of Finance (Practice) Joseph Lim says: 'This is advantageous for investors looking for a steady stream of income from their investments - for example, retirees.'
In comparison, the dividend income a share investor gets may not be as reliable.
The capital value of the bond - which the investor will get back in full upon maturity - is also more stable than the price of a share. In fact, if a company goes into liquidation, bondholders, like other creditors, get repaid ahead of shareholders.
Of course, this low-return stability can be a drawback, particularly for young investors with a longer investment time-horizon. SIM University's head of programme for finance Associate Professor Sundaram Janakiramanan notes, though, that with Singapore's stock market being highly volatile over the past three years, it could be wise to diversify into bonds 'that are less volatile, and provide periodic return'.
Risks?
Yes, like any investment, bonds have their risks too - the bond issuer could go bankrupt and default on payments, or inflation could erode any gains you make from investing in the bond.
Ngee Ann Polytechnic School of Business and Accountancy senior lecturer Chong Kek Weng says: 'The savvy bond investor needs to be aware of macroeconomic trends such as inflation, unemployment, GDP/GNP, international trade as well as government fiscal and monetary policies.'
This is especially so in the current low interest rate environment, says SMU's Prof Lim. 'Interest rates are now more likely to go up than down. An increase in interest rates will result in a fall in bond prices,' he says.
SIM University's Prof Sundaram, too, cautions that how the market price of the bond moves affects whether the investor gains or loses if he wishes to sell his bond before maturity. He thinks it is 'not prudent' to invest in Singapore bonds at the moment.
Bonds generally also lack protection from inflation. Inflation affects the real value of both your principal (what you get when the bond matures) and your interest payments.
Inflation has been rising, so one question to ask is whether it could be higher than the coupon rate on your bond, in which case, the money you've invested in the bond may not be growing fast enough to keep up with inflation. There are exceptions though - certain bonds have coupon payments adjusted for inflation.
Also, although bonds can appear relatively safer with their fixed payments, the possibility of default must still be factored in, says Prof Sundaram. 'There is always a chance that a bond issuer might default on their coupon payments or the principal at time of contract maturity.'
Bond investments Government bonds
# Singapore Government
Securities are issued directly by the Monetary Authority of Singapore (MAS) via primary auctions which are announced periodically. You can submit bids for these via the DBS, UOB and OCBC ATMs once MAS has announced a primary auction, if you have a valid individual securities account with The Central Depository. Or, you can buy and sell SGS on the secondary market through an agent bank.
# Corporate bonds
Corporate bonds are listed on the Singapore Exchange so to buy them you will need to use a stockbroker who can trade securities on SGX. You can then buy or sell them just as shares of listed companies are bought and sold, at the market price. This can be done online too, if you're using an online broker.
Mr Chong observes that bond issuance is rising in popularity among companies, which means investors 'can look forward to more choices and a greater variety of listed bonds in the market'.
# Bond funds
Bond funds are professionally managed funds which pool together small investors' monies to buy bonds. It can be an economical way for a young investor to access the wider range of bonds which are not as accessible to retail investors with no investment expertise and a smaller portfolio.
A managed fund also diversifies across a range of bonds to reduce investors' exposure to any single issuer's risks, with fund managers monitoring risks too. But this means that the company will take management fees and some professional charges.
# International bonds
Some banks here offer both Singapore dollar bonds and bonds in an international currency, issued by corporations or governments from around the world. 'There is an exchange rate risk involved when investing in foreign bonds,' notes Prof Sundaram.
Such an investment can be attractive as bonds issued in a high interest rate country such as Australia will have a higher yield than that of bonds issued in low interest rate Singapore. But as this requires currency conversion, it is a good proposition only as long as the Singapore dollar does not appreciate substantially.
Know your bond jargon
# Term of maturity
Generally, bonds with a shorter term have a lower coupon. Bonds with a longer term of maturity usually offer higher payouts due to a longer waiting time before the borrower gets back his money.
# Coupon payment
Different bonds offer different coupon rates. Holding other factors constant, bonds with higher coupons are more attractive due to the higher yearly payout that the bondholder receives.
# Rating
Agencies like Standard and Poor's and Moody's Investors Service issue credit ratings on bonds. A higher rating suggests the bond is safer and that the issuer is more financially credible - less in debt with a lower probability of default. A bond rated AAA or AA is considered 'high grade', while one rated BBB and above is 'investment grade'. Junk bonds are usually high-yield bonds whose issuers have a speculative credit rating that is below investment grade.
'The difference between the yields of different rated bonds, known as yield spreads, tends to increase while the economy is not doing well, and reduces when the economy is doing better,' says Prof Sundaram.
# Denomination
Bonds are usually denominated in the currency of the country in which the bonds are issued, though they can be issued in a foreign currency too. The yield on the bond is then related to the interest rate in the country whose currency it uses.
Some common types of bonds include:
# Fixed-rate bonds: These pay the same level of interest throughout the tenure of the bond, until it matures.
# Adjustable-rate bonds: The interest paid on these varies according to economic conditions. Such bonds are often pegged to an index, such as the federal funds one or an interbank rate.
# Zero-coupon bond: This type of bond does not pay interest during its life-span, and so is normally sold at a discount to its actual value. So the investor makes his gain when he resells the bond, or redeems it at full value.
# Convertible bond: This usually has a low coupon rate, but allows its holders the additional option of converting the bond into shares in the issuing company, at a certain price, typically fixed at a premium to the market price of the shares.
# Singapore Government Securities (SGS): These bonds are issued by the Singapore government, with maturities of two, five, seven, 10, 15 and 20 years. The Singapore government does not actually need to borrow money to finance its expenditure. Its issuance of SGS is more to provide a liquid investment alternative with little risk of default, and to establish a liquid government bond market to serve as a benchmark for the corporate bond market.
This article was first published in The Business Times.
No comments:
Post a Comment