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Bonds and Fixed Income

3 Questions To Consider Before Investing In Retail Corporate Bonds

It is not a gift from heaven.

 

Corporate bonds for the retail investor? Seems like a gift from heaven for yield-hungry Singaporeans, as seen from frothy levels of over-subscription. Currently, there are 14 retail corporate bonds available in the market. Despite the huge interest, it would be wise to ask yourself the following questions before investing.

Read Also: Buying Corporate Bonds in Singapore

#1: Do I Fully Understand The Risks Involved?

With the exception of DBS, Genting, Capitaland Mall Trust and OCBC, most of the bonds are not rated by any credit rating agencies (S&P,  Moody’s, Fitch). Ratings help to benchmark the creditworthiness of the issuer and without them, yields become subject to speculative demand and supply.

The key implication here is that the risks of junk bonds should be noted and managed accordingly. One quick way to determine what the implied credit rating of the bond is to compare the difference of the bond’s yield to maturity to that of an equivalent duration SGS bond. If this spread is higher than that of minimum investment grade (BBB-) bonds, the market is telling you that your bond is of “junk” status. This does not mean that junk bonds are completely to be avoided, but implied probability of default is higher.

#2: Am I Expecting A Free Lunch?

Perhaps the biggest perception about bonds is that they offer truly passive income. While that is mostly true with a well-diversified bond portfolio (ie. You know what you are doing). If you are a newbie, it would pay to understand how bonds work and what you are investing into.

Although the main concern for bondholders is avoiding default vs stockholders who are looking for capital gains, more attention needs to be paid to the investment, especially if yields are exceptionally high and/or extremely long duration.

Remember this: If a company does a retail bond offering, there is a good chance that they are getting a better deal as compared to the traditional institutional market (where investors are more savvy). This could come in the form of lower borrowing costs (due to oversubscription) or perpetual duration etc.

#3: What Is My Investment Plan And Timeframe?

More risky investments usually warrant a smaller weight in a diversified portfolio. This means that putting your life savings in a junk bond generally isn’t a sensible idea. Those on the high end of the investment grade scale, however, tend to have greater demand, pushing yields even lower and making it a worse deal for long-term buy and hold investors. Thus your investment objectives should determine your allocation plan, not the other way around.

Another thing to consider is the investment timeframe. If selling the bond prior to maturity is a possibility (due to financial emergencies and so on), be aware of the procedures and “how-tos” of doing it. The good news here is that retail bonds are easily traded on the SGX and are relatively liquid.

Read Also: The Singapore Savings Bonds (SSB) Is Going To Die A Natural Death

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