Are retail bonds right for you?

Are retail bonds right for you?

Last month, Singapore's aunties and uncles piled into a $200 million retail bond by Aspial Corporation, drawn to a 5.3 per cent yield, despite the high leverage of the jewellery-to-property group, reported Reuters.

It was its second issuance in less than a year.

Responding to critics who cautioned against its relatively high level of debt, Aspial said its financials and earnings outlook are sound.

The high yield beats putting money in the bank, but is it a wise decision?

Says OCBC Bank's vice-president and senior investment strategist of wealth management Singapore, Mr Vasu Menon: "When a bond's yield is high, it sometimes can also mean it carries greater risk.

"It is especially important to assess the company's credit fundamentals. If the credit fundamentals are not strong, it may be better to be cautious."

In the first place, what are retail bonds?

"Retail bonds are corporate bonds traded in smaller denominations, making it accessible and attractive to retail investors looking for better yield given record-low deposit interest rates," says Mr Menon.

He says that before 2010, the bond market here largely catered for institutional and high net worth investors, as most bonds traded here required a significant minimum investment of about $250,000.

But in September 2010, the Singapore Exchange (SGX) announced that corporate bonds for retail investors would be available on the local bourse. Today, there are 10 retail bonds on the SGX.

Says Mr Menon: "Bonds are generally more stable than equities and help inject stability into a portfolio.

"Most bonds are also less risky, in that you get the face value of the bond back at maturity if the company does not go bankrupt or default on its obligations.

"In contrast, if the share price of a company falls sharply, it can take a long time before it recovers. It may not recover fully and investors could lose a significant part of their initial investments." He says the coupon rate or annual yield for bonds are generally fixed, unlike dividends for stocks.

"Companies have a strong incentive to pay the coupons on time as defaulting could affect its ability to raise funds and borrow in the future," he says.

DOWNSIDE?

Says Mr Menon: "Retail bonds may not be as actively traded as stocks. This may pose problems for investors who need to sell their bonds urgently.

"If an investor is unable to find a buyer at the price he wants, he may have to sell at the price available which could mean lower profits or even losses."

The price of such bonds tends to fall when interest rates rise.

"Interest rates are now at record low levels and are likely to rise in the future, which could weigh on the price of retail bonds and cause an investor to suffer losses if he sells before the bond's maturity date," says Mr Menon.

To know whether the retail bond is worth investing in, assess the company's business outlook and credit worthiness. Find out if a company is heavily indebted.

Says Mr Menon: "A company with poor credit fundamentals may go bust or default on its debt and coupon payments, and it is best for investors to be cautious.

"A company with too much debt may run into difficulties servicing its debt and may be forced to sell off assets or declare bankruptcy."

One way to do so is through the debt-to-equity ratio, where you divide the company's debts by its shareholders' funds or equity. A ratio of less than 0.5 times would be ideal, says Mr Menon.

When a company has a significant cash hoard, positive operating cash flow and good business prospects, a ratio of more than 0.5 times would be acceptable, he adds. But generally, the ratio should not exceed 1.

"It may be advisable to compare the company's debt-to-equity ratio with that of its peers. If its ratio is significantly higher, it would be a worrisome sign," says Mr Menon.

Also, look at how much cash it has. A company that has little cash may have little to fall back on during hard times and may run into financial difficulties, he says.

A company's earnings prospects and its cash flow will give you an idea of whether it can make enough profits and cash to meet interest and debt obligations, he adds.

Be wary if the company is:

  • suffering from a negative operating cash flow, that is, it is spending more cash than it is generating
  • has a low interest coverage ratio - earnings before interest and tax divided by interest payments - of less than 2.5 times.

This ratio measures the number of times a company can pay interest on its debt with its available earnings, thus measuring the margin of safety it has for paying interest.

Investors should look for an interest coverage ratio of at least 2.5 times for a reasonable margin of safety, says Mr Menon.

chaihyn@sph.com.sg


This article was first published on May 1, 2016.
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