My Take on Bond Investment
A bond is a debt security, it is basically an IOU where the bond holder is the lender and the issuer is the borrower.
A bond investment is exposed to lesser risk compared with equities or preference shares investment of the same counterpart as if you base them on seniority, Bond>Preference Shares>Equities. Which means upon company liquidation, the bond holders will have a higher priority in getting more residual back. The Lehmen Brother crisis is a good example, the shareholders didn't get any residual back , the preference shareholders didn't get any residual, but the bond holders got back 30% of their initial investment.
As with all investments, there is a default risk, which in the bond context, the risk that the issuer(company) could go bankrupt and hence can no longer honor its debt obligations. So despite the seniority, there is still a chance that you may lose your whole principal investment when the issuer defaults.
In Singapore context, the minimum value for a local bond investment in sgd is $250k(1lot) and for usd $100k(1lot). It is a huge amount of money and that is why it is crucial to know what you are buying into. So here are a few bond status you can ask your broker if you are thinking of buying a particular bond.
-Straight/Complex- Ask your broker whether the bond is straight or complex. A straight bond is also known as a plain vanilla bond as there will be no additional features or mechanism other than the payment of interest at regular interval and the return of principal that was originally invested at maturity date. A complex bond has more mechanism in it ie convertible bond. If you don't like complexity and would prefer to invest in a simple debt instrument, then try to avoid complex bond.
-Subordinated/Unsubordinated- Ask your broker whether the bond is subordinated or unsubordinated. Debt loans have a ranking system within themselves too. A subordinated bond ranks below other loans, which means they wouldn't get paid out by the issuer until after the more senior bond holders were paid in full first. This means that subordinated debt is more risky than unsubordinated debt.
-Secure/Unsecured- Ask your broker whether your bond is secure or unsecured. A secure bond is less risky than unsecured bond for the fact that it has some form of collateral on the loan. Which means upon defaulting, the issuer will have to transfer the title of a particular asset or money that has been set aside on to the bond holders. This also means that secure bonds usually have a lower interest payment as compared with unsecured bonds.
-Tenure- Ask your broker what is the tenure of the bond. This is the duration you need to hold on to the bond before the issuer pay you back the principal amount(par value). I personally prefer a shorter tenure as it gives me an exit strategy and is less affected by the fluctuation of interest rates. The recent tapering have caused a deep price correction to mostly perpetual bonds(Bonds that has no tenure and goes on forever until the issuer decides to recall). One example is the drastic price difference between Genting perp bond otc and Genting perp preference shares listed on sgx now.
-CDP/Euroclear- I personally prefer my bond to be transferred to my CDP acct and not euroclear or brokerage/bank custodian. As parking your bond in a custodian will give me extra risk. You never know what will happen to your bond when the custodian itself defaults.
-Rating- Ask whether the bond itself is rated. Most private limited company bonds do not want their bonds to get rated so that they can issue a higher and more attractive yield. Do note that a bond that is not rated suggest more risk than those that is rated. If you wish to invest in such a bond, you will have to look at the mother company's(issuer's) financials. Will explain more on this in my future post.
I hope this article is beneficial to you. Make sure your broker provides you with all these info before you make your decision.