In Singapore, bonds are an important asset class that allows investors to diversify from having just stocks or properties in their portfolio. Typically, there are two main types of bonds we can invest in – government bonds and corporate bonds.
In this article, we will delve further into how to go about investing in corporate bonds in particular.
What Are Corporate Bonds?
When we invest in corporate bonds, we are lending our money to companies in exchange for an interest payment. Typically, the riskier the company, the higher the interest it has to pay to attract investors. This is also why bonds issued by the Singapore government, namely the Singapore Government Securities (SGS) bonds and Singapore Savings Bonds (SSB), pay out the lowest interest rates.
Once we lend our money to the company, it is usually free to use it as it sees fit. The uses of funds from bond issues include paying off higher-interest debt, purchasing new properties or assets, acquiring new products or businesses and many others.
Companies typically make two interest payments a year, and return our entire principal only at the end of the tenure of the bond.
What Determines The Interest Rates On Corporate Bonds?
Credit Quality Of Bond Issuer:
As mentioned, higher-risk companies have to pay more interest to attract us to invest in their bonds. The logic is simple – given equal interest rates, investors will always choose to lend to companies that are less likely to default on the payments.
As such, the government of Singapore offers a benchmark risk-free rate, and companies have to issue their bonds at a premium to it. This is called the yield spread.
One way to determine the riskiness of a company is to simply look at its business. A large international company like DBS or a government-linked entity like PSA International will very likely be paying much lower interest than even strong companies like Olam International and Chip Eng Seng.
While it gives us a good guess, this is a very rudimentary way to determine the riskiness of a company’s bond. Another way we can go about doing so is looking at its credit rating. Global credit ratings agencies like Moody’s, Fitch and Standard & Poor’s analyse the bonds (and companies) to give it a credit rating. While this is a great way to determine the riskiness of a bond, the reality is that not all corporate bonds are rated.
Typically, the longer we have to wait before receiving our principal, the higher the interest rates we should receive.
One way to look at it is to imagine the same company issues two bonds – a 1-year bond and a 10-year bond. Even though it is the same company, there is a higher risk that the company deteriorates in creditworthiness or run into financial difficulties over a 10-year period compared to a 1-year period.
Interest Rate Environment:
To understand this, we have to compare the yield spread on the risk-free rate.
Consider this imaginary situation, the SGS bonds starts paying 10% interest on its 10-year bonds tomorrow. Even the strongest companies like DBS and PSA International have to pay an amount higher than that interest rate if they want to issue a bond. This is because the risk-free rate has climbed, and they have to pay a premium over the risk-free rate because there is a greater risk they run into financial difficulties than the Singapore government.
Why Choose To Buy A Company’s Bonds Rather Than Stock?
When we invest in a company’s bonds, we are merely lending the company some money over a period of time in exchange for interest payments. Choosing to invest in a company’s stock means we become part-owners of the business.
There are several reasons we may choose to buy a company’s bonds rather than its stocks:
# 1 We receive our coupon payments regardless of the financial performance of the company. This means whether a company makes a profit or loss, we will still take our rightful interest payment. On the flipside of this argument, is that we cannot participate in the growth of the company.
# 2 We are able to preserve our capital in downturns as our principal and interest payments are guaranteed. This is also why many investors think that bonds a safer investment than stocks, which can see higher volatility during downturns.
# 3 We are able to predict when, and for how long, our interest payments will be made, and when our principal will be returned. This enables us to make concrete plans to use our funds at a future date. This reliability in knowing exactly when and how much we will receive is hard to come by in other asset classes.
# 4 Bond investors have superior legal claims to a company’s assets when it gets into financial difficulties.
# 5 We could also choose to buy bonds over more stocks to diversify our portfolio with a less volatile asset class.
How To Buy Corporate Bonds?
Similar to investing in stocks, there are two way to invest in bonds – via new bond issues or on secondary markets.
Unlike stocks, most corporate bonds are typically sold on Over-The-Counter (OTC) markets. This means you have to get a banker to help you make such transactions. To do this on our own, we can utilise platforms like FSMOne or dollarDEX to make your bond investments.
Retail bonds are a smaller group of bonds that we can invest in similar to how we buy and sell stocks – on the exchange. Here is the list of the 12 retail bonds listed on the Singapore Exchange (SGX). When retail bonds are first issued, we can purchase them via ATMs (similar to how we would invest in a new IPO). We can also trade these bonds on SGX.
Bond ETFs are listed on the SGX, and we can buy and sell them similar to stocks and retail bonds.
As recently as 27 August 2018, the first corporate bond ETF, Nikko AM Investment Grade Corporate Bond ETF, was listed on SGX. It mainly comprises bonds that are issued by government-linked companies, statutory boards, Singapore companies and foreign companies. On its brochure, it states that the yield on its index is at 3.22%.
Pros And Cons Of Corporate Bonds
|Yield||– Higher than government bonds and bank deposits||– Typically lower than equities and REITs|
|Payments||– Principal and interest payments are guaranteed
– High visibility of when interests and principal will be paid
– Payments are made regardless of profitability
– Higher priority when company runs into financial difficulties
|– Cannot participate in upside of a company|
|Risk||– Typically riskier than government bonds
– Can view credit ratings to determine if it is worth investing in
|– In economic downturns, even the highest-rated bonds can default|
|Diversification||– Offers diversification away from stocks and government bonds
– Offers ability to invest in non-listed companies
– Offers exposure to wide range of industries
– Bond ETFs offer even wider diversification
|– Still exposed to the same countries, industries, companies if invested in a company’s stock and bond|
|Liquidity||– Can trade certain bonds on the SGX
– Can buy and sell on OTC markets
|– Limited ability to trade on SGX, as most bonds are sold on OTC markets
– Many corporate bonds are still denominated in minimum bands of $100,000 or $250,000
– Have to wait close to 10 years before majority of corporate bonds mature
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