A primer to understanding corporate bonds in Singapore
In contrast to bonds that are issued by the Singapore government, corporate bonds in Singapore are debt instruments issued by local companies to raise capital from the financial markets.
As the corporate bond market here is evolving, the prospect of investing in bonds, particularly for the retail segment, is becoming more viable. That being the case, we want to highlight several key aspects to watch out for before you put your money in.
Minimum entry point
In the past, corporate bonds were only available to accredited investors since the minimum investment sum to buy such bonds was a relatively huge amount of S$250,000, which is beyond the reach for most people.
These large bonds are either traded on the Over-The-Counter (OTC) markets, where you will have to go through middlemen or agents to buy, or on the Singapore Exchange (SGX) bourse itself.
After 2010 however, the SGX made corporate bonds more accessible to retail investors by allowing the corporate bonds to be traded in smaller denominations.
These bonds are sold in lot sizes of 1,000 and they are available for purchase at a starting amount of as low as S$1,000.
Furthermore, recently in May this year, the MAS introduced new regulations to make it easier and cheaper for corporates to issue bonds that are suitable for the retail segment.
With this new framework, the hope is that more companies will be encouraged to issue retail bonds and therefore provide retail investors with an even wider selection of instruments to choose from.
Probability of default
Corporate bonds are usually assigned a rating by third-party credit-ratings agencies such as S&P (Standard & Poor's) to reflect the creditworthiness and default risk of a company.
Ratings from AAA to BBB are considered investment grade while lower ratings are considered non-investment grade, or otherwise known as 'junk' bonds.
A company with a stronger balance sheet usually has a lower chance of default and therefore is typically given a higher rating, while on the other hand, a less financially stable entity with cash-flow issues is normally associated with a higher default risk and thus given a lower rating.
To appeal to potential buyers and to compensate for the higher risk of default, lower-rated bonds tend to offer larger yields compared to their higher-rated counterparts.
Going a step further, when compared to government-issued bonds, corporate bonds are usually given a relatively lower rating since a company is more likely to default on its liabilities than the government of a sovereign state. That being said, there are exceptions whereby some countries are given extremely poor credit ratings.
An important thing to note is that while many of the larger corporate bonds in Singapore are rated by the third-party agencies, unfortunately, most of the smaller retail bonds are unrated. As such, retail investors will find it harder to gauge the risks of those bond instruments.
Investors, therefore, will need to do further research on the fundamentals of the companies that are issuing those bonds, such as their leverage ratio, among other things.
Ability to cash out
Another factor that investors should pay attention to is the ease of liquidating their bond holdings.
If an investor decides to sell the bond before its maturity date due to various reasons such as an emergency need for cash or even if they are having doubts on the creditworthiness of the bond issuer itself, there might be a problem if there are not enough willing buyers at that point of time.
The Singapore bond market is still fairly young and thus there might not yet be a critical mass of participants to allow for the smooth secondary trading of bond instruments.
For high-yield bonds, the situation might be even more challenging due to the higher risk involved with those instruments.
In addition, bonds with larger tenors are also more exposed to interest rate risks. Prices of bonds and interest rates are inversely related, which means that if interest rates were to rise during the lifetime of the bond, prices of bonds will start to fall. So if you happen to want to sell a bond during that period, odds are that you would have to incur a loss.
Thus, if you are looking to minimise interest rate risk, it might be advisable to focus on bonds with shorter maturity dates, since the time window in which you will be vulnerable to interest rate changes is reduced.
All about diversification
The growth in the bond offerings for the retail segment in Singapore is definitely a positive step to spur more participation in the local bond market. It should also be noted that Singapore is still currently one of the better bond markets in the region.
All said and done, corporate bonds are still considered one of the simpler and safer investment instruments around and they can form an important part of an individual's investment portfolio.
Although they may carry higher risk in relation to government bonds, they also offer higher yields.
With the proper asset allocation strategy, more investors will be able to benefit from these fixed-income instruments.