Bond

Is bond worth investing in?

Investing in bond generally has lower risk than investing in equities (i.e. becoming the shareholder of the company. Because of the investment risk nature, investing in bond generally will yield lower return than investing in equities.

When investing in bond, if the bond is kept until maturity, the return is known / fixed. The bondholders are promised to get:

Initial capital: Assuming the bond is purchased from the primary market when the bond is first issued, the full capital used to buy the bond (excluding the service fee) will be returned to the bondholders. For those bondholders who purchase the bond from the secondary market after the bond is issued, they might get back more money (if they purchase the bond cheaper than the initial bond price) or less money (if they purchase the bond more expensive than the initial bond price)

Coupon: in layman term, this is called “interest payment” which the bond issuers (companies who issue the bond) promise to pay the bondholders for the sum borrowed. It can be in an annual mode, semi-annual mode or quarterly mode. The interest is fixed based on the initial bond price when the bond is first issued.

Some of the investors prefer to have certainty in their investment. Hence, bond products will be preferred. Bonds are available in Malaysia market with different currencies, e.g. China Yuan, Malaysian Ringgit, US Dollar, Singapore Dollar, etc.

The risk of investing in bond is very much related to the company’s financial position. If the company is strong in cash flow and has very less debt, the risk will be low. If the company is insolvent, the repayment of the bond might be affected. Hence, it is always good practice to diversify the bond investment into several companies to avoid concentration risk.

Whether or not it is worth investing in depends very much on the investors’ risk tolerance. If the investors want to have lower risk, bonds will be preferred. Investing in bond will give the investors more certainty in term of the return as it is fixed / known. If the investors want to get more return, equities shall be preferred as the return will be similar to what the businesses can generate in long term (business profits).

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What to do with your investment when market corrects, when the bond yield hikes?

Last week, the general stock market is under the correction phase. Reporters, financial analysts and investment fund managers were saying that it was due to the increased bond yield. The investors fear that the government might increase the interest rate due to this faster than expected.

If you are selling your investment under such circumstances, you could be over-reacting. The US and the Asia market have been rallying up quite a lot since their lowest point in Mar 2020 last year. Periodic correction and market adjustment are expected. We cannot expect the market to keep going up without correction as it is an unrealistic expectation.

When the equity market is correcting due to the hike in bond yield, it denotes a good opportunity for us to accumulate value stocks or investments. We shall think about topping up or dollar cost averaging our investment than selling the investments (provided the investments are fundamentally good investments). Many researches have shown that equity market does better in higher interest rate environment than lower interest rate environment. When the economy is recovering, it is expected that the inflation will return. The government will increase the interest rate at some point of time in the future due to inflation. So, shall we need to worry about the market correction due to the bond yield adjustment? I leave the question for you to consider.

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What is the relationship among bond yield, inflation rate and bond price?

In layman term, bond yield is the “interest rate” which the bondholder will receive by investing in the bond. If the bond yield is 3%, it means the bondholder will be getting 3% return from the bond.

Bond yield and bond price has inverse relationship. When the bond price drops, the bond yield increases. Bond is issued at a fixed par value initially. Before the maturity date of the bond, the bond price is fluctuating according to the supply and demand of the market. If the demand is strong, the bond price will increase, i.e. can be higher than the initial issued par value, hence the “bond interest rate” (bond yield) will drop. Vice versa, if the demand of the bond is low, the bond price will drop to attract demand and hence the bond yield will increase.

For example, during the initial bond issue, Bond A was sold at USD100 at 5% coupon rate annually (USD 5 per year is given as “interest” to bondholders for every USD 100 bond). After a year of issuance, many bondholders of Bond A wanted to sell the bond and there were not many buyers around. Hence, the bond price of Bond A dropped to attract buyers. New bond buyers could buy the same bond at, say USD 90, lower than the initial price of USD 100. Considering the “interest” (coupon) is USD 5 per bond, the yield is no longer 5% but 5.55% (USD 5 / USD 90), an increase in the bond yield when the bond price dropped.

Bond yield is also greatly affected by the monetary policy – interest rate. The government normally increases the interest rate to slow down inflation. When the government announces higher interest rate, it means there will be higher saving rate and high borrowing rate. Corporates then tend to borrow less because the borrowing cost is higher. Savers will save more because the saving rate is higher. This will in turn curb spending and slow down the inflation.

When the interest rate is high, the bond yield will be high too. This is why, when the bond yield is climbing high recently, there is a fear that it was driven by high inflation rate. High inflation rate will lead to government increasing interest rate which will cause corporate borrowing cost to be higher and hence slow down the growth of the companies. It might in turn hurt the equity market. Read more about bond here and here.

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Bond or equity?

The current pandemic resulted more local corporate bonds to be issued to fund private projects. You shall see more bonds being issued in 2021. Is it a wise choice to invest in bond?

As a moderately aggressive investor, I personally prefer equities more than bonds. Bonds have the benefit to generate consistent income stream and more stable return over equities. However, the return is quite low compared to equities.

Source: https://www.investopedia.com

If you look at the above chart, the biggest 500 companies in US actually delivered average return more than throughout the years (with many years reaching above 10% and some years more than 20% – 30%). At such low rate environment and considering the impact of pandemic to the economy, many value stocks and equities are still trading at a discount. This will be the time for us to be more aggressively investing, fishing and hunting for more equities, especially for those who have not started investing, than to be too conservative. How to hunt for good equities? I have discussed this topic in my blog, read here. Sectors and industries to be focused on are discussed here.

One portfolio shall contain bonds because bonds serve as cushion and protection for high volatility market during this unprecedented period. I have also discussed the asset allocation of bond / equity in this blog. In conclusion, if you are not retiring yet and require growth than stability, equities shall be the preferred option.

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Which one to choose for investment? Equity or bond?

When one starts to be aware of the bond products, the next popular question which an investor ask is normally “Which one to choose for investment? Equity or bond?” If you are new to bond products, read this blog for further information.

I would say this is a wrong question. Both equity and bond are important financial instruments for one’s investment portfolio, i.e. one should invest in both equity and bond. The more important question to ask will be “How much you should invest in equity vs bond?”.

The proportion for the equity vs bond depends on the following factors:-

Age: Bond in general has lower risk compared to equity. When one grows older, one requires more stability of his investment, hence the proportion of bond should be higher compared with equity.
Goals: Bond is an income generating investment tool while equity mainly focus on growth than income generation. So, if the investment goal is on income generation, the proportion of bond should be high. On the other hand, if the financial goal is on growth, the investment should have more equity portion.
Risk tolerance: Equity is volatile in nature. If one’s risk tolerance is high, one can put more equity into his investment portfolio for growth.
Amount of capital you have to work with: This is critical as well if the capital is small, one will naturally have higher risk tolerance. For example, if the investment amount is RM 1000, even if the stock drops 50%, the loss will only be RM 500. If you are starting with big capital like RM 1 million, definitely, the risk tolerance will be lower and hence requiring higher proportion of the bond to stabilize the investment portfolio.

The usual recommended proportion of equity / bond based on the risk tolerance is as follow:-

Very conservative: 90% bond and 10% equity
Conservative: 70% bond and 30% equity
Balance: 50% bond and 50% equity
Aggressive: 30% bond and 70% equity
Very aggressive: 10% bond and 90% equity

In conclusion, having both equity and bond in the investment portfolio can balance out the volatility in a portfolio. When combining the two instruments in a structured and calculated manner, the risk can be reduced.

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What are the advantages of investing in bonds?

The main advantages of investing in bonds are various, they are:-

Income generation: the bond issuers are obliged to pay regular interest to the bond holders. Generally, the interest offered to bond holders are higher than fixed deposit rate because of the risk involved. Hence, bond investments provide regular income stream to the bond holder. For example, if the coupon rate of the bond is 7%, it means that the bond holders will receive 7% interest every year until maturity date. Unlike stock investment, the annual dividend rate is unknown and subject to the company’s performance. The bond interest is fixed.
Potential capital gain: bond prices fluctuate before the maturity date. If the bond price increases during the bond tenure, the bond holders can choose to sell the bond to another party through secondary market and have capital gain. However, the liquidity of the bond is generally lower because there is not much demand of bond because bonds are not available to the mass market but only to sophisticated investors.
Generally safer investment instrument: this is particularly true for government issued bond because the bonds issued are guaranteed by the government. However, the interest given will be slightly lower than the corporate bond. It is still slightly higher than fixed deposits.
Diversification for equities investments: Bond is served as a diversification investment tool as bond has no relationship to stock market. Hence, it does not move in tandem with the stock market. When stock market is moving downwards, bond is usually more stable and hence it reduces the investment risk within an investment portfolio.
Stability: As long as the bond holders hold the bond paper until maturity date (save that the company stays solvent), the bond holders will get back the principal amount invested (par value of the bond). The return of the bond investment is hence easily predicted.

If you are interested in investing in bonds, you can contact me via Facebook or telegram.

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How can I invest in bonds in Malaysia?

Bonds are generally available only for sophisticated investors in Malaysia. Sophisticated investor is being categorized as high networth individuals, high networth entities or accredited investors. Read here to find the definition of sophisticated investor.

However, bond is served as a very important diversification tools in one’s investment portfolio. But, how can one have bond elements in his / her portfolio before he / she is qualifying as the sophisticated investor? One can invest in:-

Managed bond fund (mutual fund): the minimum investment in bond fund starts from RM1,000. It leverages on accredited investors (various unit trust schemes) to invest in bonds. Some popular bond funds in Malaysia are Eastspring Investment Bond Fund, KAF Bond Fund, etc. There are also various high yield foreign bond funds available in Malaysia such as United Asian High Yield Bond Fund, Eastspring Investments – Asian High Yield Bond Fund, etc.
Exchange Traded Fund (ETF): On the stock exchange, bond fund is also available via ETF. Example of bond ETF is Vanguard Total Bond Market ETF (Ticker symbol: BND), iShares Core U.S. Aggregate Bond ETF (Ticker symbol: AGG), Vanguard Short-Term Corporate Bond ETF (Ticker symbol: VCSH) etc.

Generally, bond fund return is ranging from 4 to 7% per year, depending on the nature of the investment. High yield bond fund tends to seek more capital gain, however the volatility of the prices will also be higher.

For high networth individuals, bonds can be easily available via their premier bankers or bond express platform recently launched. For primary bonds, the minimum investment amount is normally higher, usually starting from RM 200,000. Bond express platform allows trading of bonds at secondary market, improving the liquidity of the bond. The minimum investment amount for secondary market bond is now available at RM5,000.

If you are interested in including bond products within your investment portfolio, please feel to contact me.

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