What is a bond?
Bond is a debt instrument where investors lend money to corporate or government entities for a defined period of time in return for a fixed or variable interest rate. Depending on where it sits in the capital structure, the yield also varies. The picture below shows a typical capital structure of a Company that borrows for its business. It ranges from Senior to Junior to Mezzanine then Equity. As you can see from the picture, the higher the protection it offers to investors, the lower the yield.
Bonds will be affected by prevailing interest rate
Besides the credit worthiness of the issuer (internal factor), one external factor affecting the yield and bond trading prices will be the risk-free rate. The upcoming Singapore Saving Bonds is offering investors with a 10 year time horizon a risk free rate of 2.4% (see the link). This means that the "benchmark" has been set for investors with this time horizon and if a corporate wants to issue a 10 year bond, it will need to include a "risk premium" to attract investors to invest in its bonds instead of the Singapore Saving Bonds.
Bonds like to dirty dance?
In case you are not aware, in bonds, there is a clean and a dirty price. I will copy and paste the definition below and the prices quoted on SGX are 'dirty" while most of the bonds traded OTC are "clean prices". Those traded on OTC are in tranches of $250,000. Dirty or Clean is just an definition - just note that the Buyer will always need to "pay the accrued interest" to the seller.
Bond is always priced at par or a slight premium of 100.25 at IPO to account for commission for brokers. Secondary bond prices are always quoted against the par value. If a bond yields 5% and trades at 100, it means that if you invest $1,000, you will get $50 as interest per year. If it trades at 95, it means that your capital outlay is $950 when you buy it in the secondary market place, you will get $50 interest per year and get back $1,000 at maturity
The bonds of many Oil & Gas companies listed here are trading at huge discounts of 50-60 cents in recent months due to oil price volatility and this reflects investors' confidence in these companies and bond price movement is usually an early warning signal that equity prices will follow suit as it will be worthless if the debt cannot be refinanced or paid. If the Company has a strong balance sheet, it will buy back the bonds from the market. If it has a weak balance sheet, as in Ezra's case (see here), it will need to get new capital injection to redeem or refinance the bonds.
Must a bond be rated?
A bond can be rated or unrated. An rated bond means that it is rated by rating agencies such as Standard & Poors or Moodys and an investment grade bond means that it is rated as BBB or better. For example, a bond issued by Temasek, will be rated AAA and is considered by the rating agencies to have a very low risk of default. Anything below BBB is considered non-investment grade or better known as "junk bonds".
How the rich became richer
You may think that the rich is not interested in bonds if the yield is too low. It's is actually not true. This is how the rich will play the bond.
Assuming an investment grade bond is offering 4%, the private bank is willing to lend money (say up to 50% of the value) to the rich using the bonds as collateral at an interest rate of 1%. In this way, the capital outlay is reduced by half and after deducting for the 1% interest expenses, the rich actually gets a levered return way above the 4% yield (say 7% for simplicity). Leverage is like fire. It is good if you use it well or disastrous otherwise.
MAS is trying to level the playing field to attract more retail bond offering
It is quite frustrating to see that the rich are getting to invest in a wide variety of bond instruments while retail investors are limited by what it can invest in. For a start, if you are a corporate, there is no frankly incentive for you to engage retail investors if you are bound by higher disclosure requirements vis-a-vis the accredited investors. (not to mention you have to incur higher distribution and marketing costs).
MAS has been trying to make it easier for retail investors to access bonds but it is still a work in progress and we are seeing encouraging signs. Fraser Centrepoint listed a 7 year $500m bond in May this year offering retail and institutional investors a yield of 3.65%. The report is here. This is followed by Aspial 5 year bonds offering 5.25%. Announcement is here. I will do up the Aspial retail bond later today.
How Mr. IPO view bonds
First of all, I must tell you that i am a "greenhorn" in Bonds as i have never considered this asset class when i was younger. Probably also due to the fact that i view the returns too low but more likely that I can't afford the $250,000 size lot.
As in many things, as i grow older and moved through different stages of my life cycle, the taste bud changes as well and i am starting to get more interested in this asset class.
To me, bonds is worth a second look as an asset class if it can achieve the following objectives for me
- It provides diversification to my current equity only portfolio
- It have a lower volatility vis-a-vis stocks (let you sleep more peacefully at night)
- It should provide a steady stream of income (provides sustainable passive income)
- It should return the principal at the end of the maturity (preserves wealth for future consumption)
I will be starting to cover retail bonds going forward and may include them in my SRS portfolio if they are deemed suitable but those have to be bought from the secondary market.
Happy Bonding with me ^_^