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7 Things We Learnt About Bonds From The SIAS Fixed Income Conference 2019

Among other things, we learnt about the financial ratios to look at when investing in bonds, as well as the checklist of 5Cs that investors need to run through before investing.


This article was written in collaboration with the Fixed Income Conference organised by SIAS. All views expressed are the independent opinion of DollarsAndSense.sg

Given the increasingly volatile markets we have been experiencing in recent weeks, we felt that it was a good idea to attend the SIAS Fixed Income Conference on 24 August, to learn more about how bonds and fixed income can support our portfolio.

Along with 1,000 like-minded investors in attendance, we spent our afternoon listening to many experienced industry participants share with us their insights about bonds and how we can best use it when building our portfolio, as well as a panel discussion to take questions that the audience had. Speakers included representatives from Singapore Airlines, Temasek and Azalea Investment Management, who shared with us about their credit story and the bonds they’ve issued.

Here are 7 things that we learned from the Fixed Income Conference.

# 1 Diversification Is Important

Every investment carries with it some form of investment risk, no matter how safe we think it is. One of the easiest ways to reduce this risk is to hold a well-diversified portfolio.

By spreading our eggs across different baskets, we will be able to mitigate some company-specific risks. This means that even if one company defaults on its bond payments, our overall investment portfolio will still continue to do well because it’s not concentrated into just one or two bonds.

Read Also: After Identifying A Good Company, Should You Consider Investing In Its Stocks Or Bonds (Or Both)?

This shouldn’t be mistaken that our investment portfolio is entirely sheltered from all risks just because we diversify. We will still face risks that impact the entire system, or systemic risks.

# 2 How To Recognise Our Risk Appetite And Create An Investment Portfolio That Reflects It

As investors, we need to understand how much risk we can bear. The rule of thumb definition: what percentage of your portfolio can you afford to lose, while still being able to sleep soundly at night?

While everyone will say that they want their investment portfolio to earn as high a return as possible, not everyone would be willing to bear the risk that is required to earn this higher return.

Historically, bonds are seen as less volatile investments compared to stocks. This also means bonds tend to deliver lower returns as compared to stocks over the long term. The logic is simple. You take lower risk but your rewards are also lower. The benefit of allocating a larger proportion of our portfolio to bonds is that our investment portfolio will typically be less volatile.

Source: Christopher Tan’s (Executive Director, MoneyOwl and CEO, Providend) Presentation Slides

This chart above shows three different portfolios, the red line depicts an investment portfolio that comprises 100% stocks, the blue line depicts an investment portfolio comprising 60% stocks and 40% bonds, the grey line depicts an investment portfolio comprising 20% stocks and 80% bonds.

Based on the chart, we can see that since 2008 to date, all portfolios have increased in value – although there is no guarantee values will keep going up. We can also see that the red portfolio increased the most, but also experienced the wildest swings among the three portfolios. On the other hand, the grey portfolio looks like it is on a steady upward track, with minimal swings in portfolio value.

As investors, we need to invest in a portfolio that is suitable with the appropriate risk level that we are willing to bear.

# 3 Types Of Risks Associated With Bonds Investing

Many of the speakers at the event talked about the risks associated with bond investing.

The first thing we have to know is that bonds “are basically an IOU (I owe you)”. This means the company is borrowing money from investors, with a promise to pay them an interest periodically and to return the principal amount when the bonds mature.

There are a few ways we can still lose money on bonds:

i) Credit Risk– If a company goes bankrupt, it may default on its interest payment or even the capital repayment.

ii) Currency Risk– Even if the company does not default or becomes a riskier investment, any depreciation in a bond listed in foreign currencies will mean that we suffer a loss on the return we should have got. For example, if we buy a bond denominated in US dollars (USD), and the USD depreciates by 10% against the Singapore dollar (SGD), our returns will be 10% lower than what we originally expected.

iii) Liquidity Risk– if we are in need of cash and need to sell our bond investments, there may be a risk that we have to lower our asking price in order to find a buyer for the bond, and in the worst case, we may be unable to find buyers in the market.

iv) Interest Rate Risk– interest rates and bond prices tend to have an inverse relationship. This means when interest rates go up, bond prices typically go down. You could lose money if you are unable to hold the bond and need to sell it before maturity.

There may be other types of risks that you should note as well, and you can read this in-depth article on some of the risks discussed above as well as others.

# 4 Seniority In Payouts

When comparing bonds to stocks, bonds will enjoy seniority in payouts. This means that in a situation where companies become insolvent, bondholders will receive their investments ahead of shareholders in a liquidation.

This lowers the risk for bondholders, as it gives them legal protection in situations where companies go bankrupt and are forced to liquidate.

However, this should not lull bond investors into a false sense of security as we have already seen bond investors being unable to recoup the full amount or having to take a haircut to allow the company to continue operating.

# 5 What You Need To Ask Before Investing In Bonds

We also learned the questions we need to ask to become successful bond investors. Here are 5 Cs you should be asking yourself before you start investing in bonds.

i) Company: When investing in a company’s bonds, don’t just look at how much interest returns you are being promised. While the company may be obligated to pay you this interest rate and the principal regardless of whether it turns in a profit or loss, if it gets into financial difficulties, you stand to lose a substantial portion of your investment as well.

ii) Credit Rating: Some bonds are rated by international credit ratings agencies, such as S&P, Fitch and Moody’s. Typically, anything above a BBB rating is considered investment grade, and anything below it is considered junk. However, it is important for us to note that rating agencies use their own rating criteria and frameworks to make their assessments. They specifically warn retail investors from using their ratings when making investment decisions as their methodology may not be the same as what retail investors consider important.

That said, the higher the ratings of a bond, the safer it is. Here’s a table depicting bonds ratings.

Source: DollarsAndSense

iii) Currency: We briefly touched on this point earlier – before investing, we need to know which currency the bonds are being issued in. If we invest in a bond that is denominated in a foreign currency, fluctuations in the exchange rate can have major repercussion on our investments.

iv) Coupon Rate: The coupon rate is how much the bonds will be paying out and how often will it be paying out.

v) Can Hold?: Another important question we need to ask is whether we are able to hold the bond to maturity. If we hold a bond to its maturity, we will be paid back our principal investment, regardless of how market forces or interest rates impact its price. The keyword here is “if”, as thinking we can do so, and not being able to do so subsequently can be costly.

Read Also: 4 Reasons Why Some Investors Choose Bonds Over Stocks

# 6 Financial Ratios To Look For

Beyond just announcements related to a company’s bonds, we should also look at its financial results to uncover more information. A quick overview of a company’s financial ratios can guide us in understanding whether it may face difficulties repaying its bonds.

Here are some commonly used financial ratios that bond investors can use when evaluating a company’s finances:

i) Leverage Ratio (e.g. Debt/Equity)

A company’s leverage ratio is a basic measure of a company’s ability to meet its financial obligations. The ratio tells us how the company is financing its operations, with a higher leverage ratio telling us that the company is using more debt to finance its operations.

It is also an important figure to inform both shareholders and bondholders of the company’s ability to cover its debt with just its shareholder equity, in an insolvency scenario.

A higher figure means the company has a greater percentage of debt, and thus have a riskier outlook.

ii) Interest Coverage Ratio (e.g. EBIT/Interest Expense)

A company’s interest coverage ratio tells us how many times the company is generating sufficient revenue to cover its interest expense comfortably. A higher figure means the company is in a better position to pay its interest expense, and this makes it a safer investment.

iii) Debt-To-EBITDA

A company’s debt-to-EBITDA ratio tell us of the company’s ability to pay off its debt from the actual profits it brings in. A higher figure means the company has a greater amount of debt, and at higher risk level.

When calculating these ratios, it’s important that we don’t jump to conclusions. Firstly, we should use this figure in complement it with other information that we should also be looking at, such as the company’s credit rating and the bond’s credit rating. We should also compare it to its peers, as certain industries are typically more highly levered in general.

# 7 The Best Defence You Have Is Knowledge

In the opening speech by David Gerald, President and CEO of SIAS, he mentioned something very basic but rang so true. If we have knowledge, we cannot be misled, hard-sold or, worse still, scammed.

In the absence of full understanding of an investment, our default response should be to say “no”, regardless of how lucrative an investment opportunities may appear to be. If we truly think we are letting go of great investment opportunities, we should put in the time and effort to try to understand them better.

As we become more discerning investors, we can start to tap on many other opportunities. One simple advice Mr David Gerald offered was “don’t look at companies and jump to conclusions”.

He was likely referring to Hyflux, and its now defaulted bonds, affecting close to 34,000 bondholders. Instead of understanding the company and the bonds they were investing in, many investors were attracted by other things that may not have been relevant to what they were investing in:

  • “Big water company – cannot go wrong in Singapore”
  • “Olivia Lum has been presented many awards by the government”
  • “The bonds were listed on SGX, so they are surely safe”
  • “Temasek had previously invested in the company – sure good one”

Building Our Investment Knowledge

There are many things we need to know when it comes to investing, whether in bonds or stocks. Our knowledge should not paralyse us from making investment decisions just because we are worried that there is a chance that the investment outcome will not go our way. Rather, it should allow us to make better, risk-optimised, investment decisions for ourselves.

Some ways we can do so is by speaking to family and friends who are financially savvier, seeking the thoughts of our financial advisers, attending events, such as the Fixed Income Conference, to learn more about investing and going online to learn more.

Partnering investors, SIAS also plays its role in organising events and even dialogue sessions for shareholders and bondholders, with the companies they invest in. In fact, SIAS has held close to 40 such session in 2019 thus far. To attend one of these session, we can refer to the SIAS event calendar.