Monday, January 9, 2012

Another way to diversify your assets

Straits Times: Sun, Jan 08
There is a rocky year ahead so a well-diversified portfolio is essential, which means it's as good a time as any to look at adding corporate bonds to the mix.

Bonds can be daunting to many investors, even though they are proving popular.

CapitaMalls Asia (CMA) launched $100 million worth of retail bonds on Tuesday and promptly expanded the offer to $220 million because of huge demand.

CMA also issued a placement tranche of $100 million worth of bonds for institutional investors, but that was more than two times subscribed so it was increased to $180 million.

But what are retail bonds and how do they differ from preference shares, which are a very similar asset?

What are the pros and cons of retail bonds?

Here is the basic guide.

What are retail bonds?

Bonds are debt issued by firms and other organisations that offer fixed interest or coupon payouts until maturity, when investors get their initial sums back.

A retail bond simply refers to a bond that is available to retail investors.

Investors can initially subscribe for these bonds through ATMs, and then trade them over the Singapore Exchange. They are kept in the investors' Central Depository accounts.

All investors can also buy or sell retail bonds and Singapore Government Securities through their stockbrokers.

Retail bonds are relatively new to Singapore.

Previously, investors had to buy through bond funds or private banks and fork out huge outlays - $100,000 or $250,000.

In 2010, Singapore Airlines became the first listed company to offer retail bonds here, with a minimum subscription of $10,000.

It received such a strong take-up that other companies, including Fraser & Neave and CapitaMall Trust, have followed suit and the minimum investment amount has fallen to as low as $1,000.

But the uncertain market conditions last year led to a dearth of retail bond issues; CMA is the first company to launch retail bonds here since last March.

How are retail bonds different from preference shares?

Retail bonds and preference shares are very similar instruments.

Both offer regular dividends or coupon payouts to investors, both experience generally lower volatility and trading liquidity than equities, and both have a right of claim to a company's assets and earnings.

However, the two differ in risk.

'Preference shares are still shares, so they rank lower than bonds in the event of credit default,' explains Mr Vasu Menon, OCBC Bank's head of content and research for wealth management for Singapore.

'If the company that issues the bond goes bust, the bondholders are first in line to receive repayments, followed by preference share holders then common equity holders.'

Another difference is the fact that companies issuing preference shares are not legally obliged to pay regular dividends, notes HSBC Singapore's head of retail banking channels, Mr Marcus Teo.

'However, preference shares are obliged to accrue for future payouts should the company's board of directors decide to withhold dividends,' he adds.

'Bonds, on the other hand, have a legal obligation to pay its contracted coupon. Failing to do so will constitute a default.'

The third difference: Preference shares generally do not have a fixed maturity timeframe but are callable by the issuer.

That means the issuer can buy back the preference shares on a specific 'call date' at a fixed price.

Bonds, on the other hand, have a fixed maturity date, Mr Teo notes.

Bond prices generally have an inverse correlation with benchmark interest rates, while preference shares tend to be more volatile and correlated to equities' price movements, he adds.

Bond prices tend to move in the reverse direction of interest rates, because investors as a rule view fixed-income products such as bonds as an alternative to savings accounts.

If banks start offering higher interest rates on their deposit accounts, new bond issues would offer even higher yields; existing bonds would look less attractive in comparison and so their value would fall.

'It can be argued that while the two different types of securities generally attract investors seeking fixed income, there is less certainty and more volatility associated with preference shares,' says Mr Teo.

'Preference shares are also widely regarded as a hybrid security between a common stock and a bond.'

What are the risks of retail bonds?

First, as with any other investment product, there is a risk that the issuer will go belly up.

'You have to look at the underlying fundamentals: Is the company going to run into financial difficulty?' says Mr Menon.

Second, bonds are illiquid. Most days, some retail bonds listed on the SGX do not change hands at all. And because trading is so thin, the bid-ask spreads are wide, meaning investors wanting to sell would probably have to do so at a low price.

'For many of the existing retail bonds, the returns would not be fantastic,' Mr Menon notes.

'When you buy the bonds you would have to pay, say, 0.25 per cent broker commission, and when you sell you would have to pay another 0.25 per cent, so that's 0.5 per cent lopped off your returns. So people tend to buy bonds with a very long-term view.'

However, SGX's head of fixed income, Ms Tng Kwee Lian, says trading activity in retail bonds has been picking up gradually.

'We are happy to note that the bid-offer spreads for Singapore Government Securities have narrowed about 30 to 50 per cent across all maturities since the bonds began trading on the SGX, compared to the previous practice where investors buy or sell at the banks,' she says.

Increased retail participation in bond investing will also contribute to better liquidity over time, she adds.

Third, there is the risk that interest rates might rise and affect the value of your bond.

However, the low liquidity and the interest rate risk would only be a problem if an investor is looking to sell his bond holdings before they mature. If an investor holds the bonds to maturity, he would receive his original investment amount back in full.

There is nonetheless another risk to take into account even if one plans to hold the bonds to maturity - inflation.

Rising inflation will weaken the purchasing power of the coupon yield and principal investment amount.

Nonetheless, OCBC's Mr Menon believes there is space for retail bonds in most portfolios.

'There has been a positive development in the last five to eight years, that more people are seeing value in asset allocation,' he says.

'Investors now realise you can't throw all your money into equities. They have since warmed up to Reits (real estate investment trusts), preference shares and bonds, and I think all of these assets have a place in a portfolio.'

Buying and selling costs

'When you buy the bonds you would have to pay, say, 0.25 per cent broker commission, and when you sell you would have to pay another 0.25 per cent, so that?s 0.5 per cent lopped off your returns. So people tend to buy bonds with a very long-term view.'

-- MR VASU MENON, OCBC Bank's head of content and research for wealth management for Singapore

Source: The Straits Times © Singapore Press Holdings Ltd

Team Marshe
Martin Koh/ Sherry Tang
9383-3992/ 9844-4400

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