Those of us who have studied finance in school would definitely have been taught concepts regarding bonds. Namely, the basics such as yield to maturity, coupon rates and so on. Nonetheless, the bond markets of today require greater sophistication to understand. In this article we will talk about certain non-standard clauses/commonalities that appear very often among local retail bond offerings.
#1: Perpetual Bonds
Very common among retail bond offerings, perpetual bonds are, like the name suggests, bonds that do not mature. This skews the traditional understanding of bonds, and does not offer the principal-guaranteed payoff that conventional bonds do (ie. Never have to pay back the principal you invested).
Issuers typically offer higher yields to compensate for this privilege. Common sense should be key if and when you decide to invest in such bonds for the long run, by choosing issuers with no likely issues with liquidity in the long haul. Of course you could unload such bonds in the secondary market, but that would require an element of market timing that would subject your investment to capital loss risk (something you might not desire in a fixed income investment).
#2: Callable Bonds
In basic terms, callable bonds are bonds that allow the issuer to redeem the bonds usually at par value or slight premium to par before maturity. Why would issuers do that? If interest rates have declined significantly from the time of issuance, issuers are able to refinance their debt at lower rates, thereby reducing their cost of borrowing.
So far for retail bond offerings, these are limited to perpetual bonds. These provide some assurance for investors, who are looking for an eventual exit as in the case of typical bonds. However, it should be noted that the issuer has no obligation to redeem the bonds. Should the issuer choose not to – outside of selling the bond in the secondary market – the investor has no way out of the bond.
#3: Many Are Not Rated
Among institutional corporate bonds, it is industry practice to have credit ratings to signal creditworthiness of the issuer to the market. However, many retail bond issuers are N.R. (not rated), again offering higher yields to compensate. The problem with this is that there is no benchmark to price the bond yield, and it becomes subject to speculation of market supply and demand.
Ultimately, if your purpose to invest in bonds is to generate cash flows conservatively without risk of loss, then investing in non-rated bonds adds an element of risk that you may not be comfortable with. To draw parallels, the risk profile could be the same as (or even worse than) that of p2p lending. As with all investments, it would be wise to rely on your own analysis of the fundamentals and your financial goals before investing – instead of basing your decision on a little extra yield.