What are Bonds?
A Thorough Comparison & Analysis
Bonds are tools of debt. When you purchase a bond, you lend funds for a fixed rate of exchange to the company or government institution issuing the bond. Bonds are legally sophisticated ‘IOUs’ in that sense, which can be traded among investors.
A bond issuer will make interest payments to the investor, at regular intervals until the bond maturity, when the issuer is statutorily required to return the principal.
The coupons are paid quarterly, semi-annually or annually at periodic intervals. This can be an investor’s source of regular revenue, bonds are also regarded as fixed income products.
What is Bond Investing?
Is investing in bonds truly “risk-free”?
Watch this to find out what bonds are and how they work
Table of Contents
Introduction to Bonds
What are the different types of bonds?
Before we start, you will need to understand the difference between some of the bond products.
You can choose between the Singapore Government Securities (SGS) and Singapore Savings Bonds (SSBs) in Singapore. These are supported by the Singapore Government and deemed risk-free investments.
Savings Bonds are intended as a flexible, low-cost and low-risk savings product specifically for retail investors.
Difference between Singapore Savings Bonds & Singapore Government Securities:
Singapore Savings Bond
- Not tradable.
- Can redeem the full principal plus accrued interest in any given month, with no penalty.
- Minimum investment amount and unit size of $500.
Singapore Government Securities:
- Can be sold on Singapore Exchange.
- Early redemption is not available, but it can be sold in the secondary market. Note: Prices may rise or fall before maturity.
- Minimum investment amount and unit size of $1,000.
Companies issue corporate bonds. Usually, they pay higher interest rates than government bonds as they carry more risk in general. The same way you would purchase stocks, you can purchase corporate bonds listed on SGX, with paying the ordinary brokerage charges.
Many corporate bonds are only available to investors with at least $250,000 to fork out per trade.
Typically, perpetual securities pay higher distributions than the same issuer’s plain vanilla bonds* to compensate investors for the higher risks involved. These include keeping the perpetual securities permanently and the risk that distributions may be deferred and that interest may not accrue.
*Plain vanilla bonds usually refer to bonds which are unsecured and rank senior (or equal) to other debt obligations of the issuer during a liquidation.
Investing in bond funds and ETFs is generally more practical than directly investing in all the bonds held by the fund. Some ETFs are Investment Products Specified (SIPs).
Bond ETFs are typically intended to track bond index performance. They may invest in or reproduce a portfolio of bonds through the use of derivative products such as swaps. Various bond ETFs can introduce different strategies.
How does bond work?
What happens when a bond issuer goes into default
In an occurrence of default from bond issuer:
- Fails to pay interest or principal on the due date of payment.
- Fails to comply with financial covenants, such as ensuring that net loans to net equity do not exceed a certain percentage.
You may lose all or a significant portion of your investment if a default occurs.
Understanding bond terminology
Why bonds have different coupon rates
Low credit quality issuers usually pay higher bond coupon rates. This is because there is a higher likelihood of default when an issuer has a lower credit quality. Typically, such issuers issue bonds with greater coupon rates to compensate investors for greater risks.
Evaluate the issuer’s credit risk by using credit ratings or credit metrics if you have the risk appetite for investing in their bonds.
A credit rating is often assigned to borrowers and the bonds they issue. For the company or country issuing bonds, there could be a separate rating and another rating for the bonds themselves. So the issuer rating is not necessarily the same as the bond rating.
Credit ratings are an indication of the creditworthiness of a bond issuer with respect to its bond obligations.
Non-investment grade bonds are also frequently referred to as junk bonds or high yield bonds, offering a much higher yield to offset the greater likelihood of default. In impact, bonds are not always a low risk; some may be riskier than stocks.
Not all bonds are rated by major rating agencies or international agencies. Some issuers of bonds may not be looking for a credit rating. For instance, if the issuer feels that they are adequately acquainted with their target investor markets and may even consider them more creditworthy than a credit rating might have suggested.
For the same reason, if the bonds are intended for a domestic market that already knows them, smaller and less frequent issuers may also not want to bear the cost of rating fees.
For such unrated issuers and bonds, when deciding whether to invest in the issuer’s bonds, you should consider other measures of the creditworthiness of the issuer and the characteristics of the bonds.
The benefit of investing in bonds
Investing in bonds has many advantages, including income, diversification, principal protection, and potential tax savings.
Risk involved in bonds
Interest rate risk is the most well-known risk on the bond market – the danger of falling bond prices as interest rates rise. In buying a bond, the bondholder has agreed to a fixed rate of return for a specified period of time.
4 ways for investors to get into bonds
Most corporate bonds can only be acquired from investors with at least $200,000 per trade.
However, there are now avenues open to small investors with a minimum of just $500. Below are the choices for Singapore investors to invest in bonds.
Traded on Singapore Exchange (SGX). They can be purchased and sold in “board lots” or at least 1,000 unit trade sizes. There are approximately a dozen such bonds traded on the SGX. Prices for buying/selling are accessible on the SGX website.
If investors want their bond investments to be diversified for a comparatively tiny amount, a bond exchange-traded fund (ETF) is an option. Depending on the specific ETF, there are few bond ETFs traded on the SGX with a minimum board lots of 100 units. These ETFs offer diversified investment in Asian corporate and Singapore government bonds.
Investors in Singapore can access a broad range of unit trusts that invest in various bond market segments – government bonds, investment-grade corporate bonds, high yield bonds, etc.
This provides an alternative to fixed deposit accounts with a higher return. You can invest as little as $500 in SSBs. They are issued and supported by the Singapore government, which has the highest credit ratings from the top three credit rating agencies in the world.
Since Singapore Savings Bonds (SSBs) are backed by the Singapore government and can be regarded as risk-free.
What to know before buying Singapore Savings Bonds (SSB)?
There are a few important things about Singapore Savings Bonds (SSB) that you need to know before you invest …
Singapore Savings Bond interest rates
There are two sets of numbers on the website: interest rate and average return per year. This is because of the interest rate step-up from year to year.
You’d like to understand what kind of returns you’re looking at if you’re buying an SSB. It’s easy to hold on to. Just look for published SSB interest rates on the official website.
Every month, new bonds are issued, and interest rates differ
For example, the interest rate is 1.63% a year from Years 1 to 3, but it changes to 1.68% in Year 4. So if you withdraw after Year 4, your actual returns from the entire investment average out to 1.63% per year (1.62% + 1.62% + 1.62% + 1.68%, divided by 4).
How to screen and filter for Singapore Savings Bonds?
If you’re new to invest, MAS has also included some Investor Guides and Calculators at their homepage. This will help you understand better with the Step-by-step guide to investing in Savings Bonds, on how to buy, redeem and manage your Savings Bonds.
You can also view the current interest offering of Singapore Savings Bond.
Which is the best bond for me?
While our intention to invest is to generate profits, we also need to be intelligent in selecting the correct strategies that make sense to you. Here are some variables to consider before deciding on the investment strategy that works best for you.
1) Know how to identify and analyze – In order to be profitable in investment, you need to know how to identify and analyze Bond ETF funds as well as understanding the different types of bond in the market.
2) Diversification – to better manage risk, you should look into what the funds portfolio are invested. You should go for the most suitable funds according to your desired risk-return profile.
3) Know your Risk Tolerance – before you start buying Bonds ETFs/UTs or SSBs. Different types of bonds have a different level of risk. Investing in higher yield bonds tends to be much riskier and may have a lower credit rating. In contrast, SSBs tend to be considered as risk-free since they are backed by the Singapore government.