This article was first published on 29 October 2018 and been updated to include the latest information.
In Singapore, bonds are an important asset class allowing investors to diversify from having just stocks or property investments 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 deeper into how to start investing in corporate bonds in Singapore.
What Are Corporate Bonds?
As its name suggests, corporate bonds are issued by corporates or companies. When we invest in corporate bonds, we are lending our money to these 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) 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 typically include paying off higher-interest debt, purchasing new properties or assets for the business, acquiring another business or investing in new products and many others.
In recent years, corporate bonds may have come under a bad rap as defaults on bonds issued by Hyflux, Swiber and Noble Group. This is why we need to remain prudent when investing in corporate bonds rather than just assume it to be safe.
Corporate bonds typically make semi-annual coupon payments every six months, 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 likely pay much lower interest than even strong companies like Olam International and OUE Commercial REIT.
While simply looking at the strength of the company gives us a good estimate of its riskiness, this is a rudimentary way to determine the riskiness of a company’s bond. Another way we can go about doing so is by looking at its credit rating. Global credit ratings agencies like Moody’s, Fitch and Standard & Poor’s analyse bonds (and companies) to provide a credit rating. While this is a better 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.
We also attach a greater premium to bonds that only return our principal after a much longer period of time.
Interest Rate Environment:
To understand this, we have to compare the yield spread on the risk-free rate.
Consider this imaginary (but far-fetched) situation, the SGS bonds start paying 10% interest on its 10-year bonds tomorrow. Even the strongest companies like DBS and PSA International have to pay a higher 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.
Similarly, in the low interest rate environment today, where government bonds are issued at under 1% per annum, poorer quality companies may be able to issue bonds offering lower interest rates than before.
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. However, we typically only receive dividends from a company if it has strong cash flows and is profitable. On the flipside of this argument, we cannot participate in the growth of the company by just investing in its bonds.
#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 usually experience more 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. Stock investors will only be able to get their money after bond investors and other creditors are paid.
#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 ways 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 invest in bonds and bond funds.
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 11 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 buy and sell these bonds on SGX like stocks.
Through this, we can gain access to quasi-government companies such as Temasek Holdings’ bond issue as well as Astrea IV and Astrea V, enabling us to access private equity.
Bond ETFs are listed on the SGX, and we can buy and sell them similar to stocks and retail bonds.
The first and only corporate bond ETF, Nikko AM Investment Grade Corporate Bond ETF, was listed on SGX in August 2018. It mainly comprises bonds that are issued by government-linked companies, statutory boards, Singapore companies and foreign companies. On its factsheet, it states that its weighted average yield to maturity is at 2.29%.
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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