We’ve all been here before.
For the uninitiated, investing in Bonds can pose a tough challenge.
With so many different concepts, variations, and nomenclatures being used, novice investors would have to spend hours perusing the internet to sieve out useful information to start on this instrument.
Nonetheless, it would be quite foolish to simply ignore this asset class. The prospect of a stable investment with consistent payouts can help to boost the overall return of your portfolio.
The bond market in Singapore is one of the most advanced ones in Asia, and can offer some interesting fixed income alternatives as compared to equity.
In this article, we’ll delve into the subject of bonds in a Singaporean’s perspective. And how you can begin investing in this asset class.
A Primer To Bonds
A bond is a debt instrument which represents a loan made by an investor to a borrower. Owners of bonds are debt-holders, or creditors, of the issuer.
Bonds are like a contract in which the issuer owes the holder a debt and is normally obliged to pay them interest, and also the principal (initial amount) at a later date. Interest is usually payable at fixed intervals. This can be on a monthly, semiannual, or annual basis.
Unlike stocks which are ownership shares of a company, a bond is a creditor stake in the company. As a creditor, this means they will have priority over stockholders in the case of a bond default.
Bonds are normally held as a proportion of an investor’s portfolio, in order to provide a form of fixed income, and better safeguards against volatility.
The Secondary Market
Sometimes, the bond can also be transferred in the secondary market. This means that the price of a bond can fluctuate depending on global interest rates, and supply-demand dynamics.
This is because the attractiveness of a bond varies in relation to the current interest rate set by the market. A bond with a higher interest rate as compared to the current market’s rate would be more appealing, thus driving a higher value.
In Singapore, this market would likely be the SGX, otherwise known as the Singapore Exchange. Some bond Unit Trusts, and bond ETFs also provide exposure to such tradeable bonds.
An example of such bonds would be SGS bonds, T-bills, and Corporate bonds which are traded on the local stock exchange, and through the local banks.
On the other hand, bonds such as SSB bonds are not tradeable, and therefore carry the same value throughout their contract duration.
The Issuing Entity
The two main organizations which issue bonds are the Singapore government, and also corporate entities such as banks, REITs, and property developers.
These establishments require large sums of cash to finance projects, and conduct their business operations. Tapping on bonds for such funding can be a highly viable option, especially when interest rates are low.
Corporate bonds normally come with a risk rating from one of the three prevailing bond rating agencies, and are classified as either investment grade bonds, or junk bonds.
Another point being that, compared to government bonds, corporate bonds are considered somewhat riskier, and generally tend to carry higher interest rates.
Government bonds are normally issued by the Monetary Authority of Singapore, otherwise known as the MAS. Examples of such bonds include SGS, and SSB bonds.
Sovereign governments are also rated by the bond agencies, with the Singapore government carrying a bond rating of AAA, the highest possible rating for a bond issuer. This displays the quality of the issuer, and allows our government to attract funds with a lower interest rate.
Terms And Conditions
Because bonds are essentially financial contracts, they also have to abide by the terms and conditions stated therein. It’s really up to the issuer to dictate the terms of the bond, so long as they are still able to attract investors.
As a norm, we tend to see some standard practices within the global bond market. I’ve listed out some of the usual suspects below.
- Fixed rate bonds. Your basic vanilla bond, fixed rate bonds pay out a predetermined interest rate to creditors on a preset schedule. Investors have full clarity on the duration and return from the bond.
- Step up bonds. A step-up bond is a bond that pays a lower initial interest rate but includes a feature that allows for interest rate increases at periodic intervals. Singapore saving bonds, or SSB bonds are one such example.
- Inflation-linked bonds. These bonds help protect investors from inflation by contractually linking the bonds’ principal and interest payments to a recognized inflation measure such as the Consumer Price Index (CPI) in the U.S.
- Floating rate bonds. Such bonds have a variable rate of interest, which is tied to a predetermined benchmark rate, plus a set base rate. Bondholders can benefit from higher interest rates if the current market rate increases.
- Perpetual bonds. Perpetual bonds have no maturity date, which means there is no deadline for the issuer to pay back the principal in full. However, the bondholder must be paid interest for as long as the contract is valid.
- Zero coupon bonds. These bonds are issued at a discount to it’s face value. Upon maturity of the instrument, bondholders will receive the full face value of the bond. This capital gain is where the investor makes a profit. T-bills from MAS are one such example.
Benefits Of Bonds
While stocks are fundamentally tagged to the perceived performance of a business entity, the value of bonds tend to shadow it’s interest rate, which is quite predictable.
This causes bonds to be much less volatile than equity instruments, and when held to maturity can offer more stable and consistent returns.
Furthermore, bonds generally offer much better interest rates compared to most saving accounts, and can serve as a passive income instrument if the interest payout is substantial.
Bonds also come in many variations to suit different portfolios. A investor might choose a floating rate bond to hedge against rising interest rates, while another might purchase a bond maturing in two years to prepare for a large purchase.
The Risks Involved
A common fault of bonds is exposure to interest rate risk; a rising interest rate environment would cause bonds with lower interest rates to be less attractive.
This would affect the market value of bonds which are tradeable on the secondary market, but will also lower the yield on non-transferable bonds as well.
What’s more, the entity which issues the contract can default on the bond if it faces problems repaying. This is a worst case scenario which would put the principal of the bondholder at risk.
Bonds In Singapore
With a well established local bond market, investors have no lack of choices when it comes to these instruments. Here are some of the available bonds in Singapore.
- SGS Bonds. Issued by the Singapore government, these bonds have a fixed payout and are tradeable on the secondary market. They can be brought and sold on the SGX.
- SSB Bonds. Non tradeable bonds issued by the government. Have a built-in step-up component for it’s payouts. Can be redeemed in any given month.
- SGX Corporate Bonds. Although most corporate bonds are only offered to accredited and institutional investors, there are a few which are offered to retail investors. They are tradeable and can be brought and sold on the SGX.
- T-bills. Short-term Singapore Government Securities issued at a discount to their face value. Mostly 6 months to 1 year maturity dates. Tradeable on the secondary market. A zero coupon bond.
- Bond ETFs. Similar to a equity ETF, these instruments can be brought and sold on the SGX and through certain banks. Popular ones include the ABF SG Bond ETF, and the Nikko AM SGD Investment Grade Corporate Bond ETF.
- Bond Unit Trusts. Different investment houses also offer Bond unit trusts, which adhere to different investment mandates. It’s important for investors to scrutinize the mandate thoroughly to verify what kind of bonds they invest in.
To End Off
It’s pretty common for equity instruments to steal the limelight when it comes to capital gains. The concept of savvy investors hitting the jackpot with solid stock-picking skills is well-emphasized to retail investors.
On the other hand, bond investments are considered a lackluster asset class due to the perceived low returns, and are only meant for wealthy investors looking to preserve wealth.
But if you believe in a holistic approach to wealth accumulation, it should be considered essential for a well-rounded investor to understand how bonds work as well.
This will give you more options when building your portfolio, or at least increase your understanding of the financial markets, both of which are beneficial in the long run.