All this while, I’ve been talking about equities and stocks as investments. It would be unfair to people who are more conservative towards risk to keep focusing on those vehicles only. You can find out what’s your risk appetite in a recent post I did. So other than saving up in the bank, what other options are there for the less adventurous? There is one investment vehicle known as bonds that fits the bill. And no, it’s not related to spies and espionage!
Disclaimer: Just a little reminder here that this is not, in any way, professional financial advice. It’s for you, dear Readers, to use as a stepping stone to further your financial education. So take what is written here with a pinch of salt.
As usual, bonds are a class of investments and like all investments, they carry risks of financial loss if the investor is not careful. So invest smart and stay savey, Readers!
What are bonds?
Not to be confused with a contract bond, in investing, bonds are an asset class derived off debt. Whose debt, you ask? Well, it’s anyone who wants to raise money for certain projects, refinance debt or simply need money for operational costs; namely companies and governments. This money you pay them will be used to finance whatever projects and so in essence, you become the creditor or loaner (instead of being the one going in debt, for a change). The key characteristics which makes a bond different from other assets are:
Face Value
The face value is the promised “payout” at the end of the bond’s life, known as maturity. If you buy the bond at a lower price than the face value, you’d have bought it at a discount!
Coupon Rate
Bonds are usually referred to as “fixed-income securities” because they pay out a predefined percentage, known as coupon rate. This coupon rate can be thought of simply as the bond’s “interest rate”.
Coupon Date
The frequency of payment is also predefined. Usually we see the payout annually or semi-annually.
Maturity Date
This is the date when the bond issuer pays out the face value to the holder of the bond.
Bonds are usually thought of as the “opposite of stocks”. In certain ways, they seem to be! Example: when interest rates are high, stock prices usually rise and bond prices fall; and when interest rates are low, the opposite is happens. Now, it’s not for certain to happen but usually that’s the trend!
What happens when you invest in a bond?
Let’s say you buy bonds at $1,000 face value of a (fictional) company, Emaibee, which has a coupon rate of 5%, coupon date of yearly and maturity of 10 years later. Every year, you will get $1,000 x 5/100 = $50 so after 10 years you would have earned $500 worth of coupons and on maturity $1,000 is paid out!
Are there risks in investing in bonds?
One of the enticing characteristics about bonds is that they’re considered low risk. The risk is perceived as lower because at maturity, you should get your money back (the face value). But still there is an element of risk of losing money when investing in a bond, even if it is small. Here is a quick rundown of the risks associated with bonds according to Investopedia:
Reinvestment Risk
One risk is that the proceeds from a bond will be reinvested at a lower rate than the bond originally provided. For example, imagine your $1,000 bond of Emaibee. Each year you receive $50 (5% of $1,000), which can be reinvested back into another bond. But imagine that over time the market rate falls to 1%. Suddenly, that $50 received from the bond can only be reinvested at 1%, instead of the 5% rate of the original bond.
This may not be a huge risk in terms of losing money but it’s still losing potential profits.
Call Risk
Some bonds are “Callable” meaning they have have provisions which allow the bond issuer to purchase or “call” the bond back from the holders and retire the issue. This is usually done when interest rates have fallen a lot since the issuance. So the issuer decides to cancel the old, high-rate bonds and sell low-rate bonds in a bid to lower debt costs.
Think of it as kind of like a refinancing strategy for a loan with lower interest rates.
Default Risk
This risk refers to when a bond’s issuer is unable to pay the coupon or face value on the bond. You should check out credit ratings services such as Moody’s, Standard & Poor’s and Fitch for the credit ratings of bond issues. This will help give you an idea of how likely it is that a payment default will occur.
For example, most governments have very high credit ratings (AAA), making default unlikely. However, small emerging companies have some of the worst credit (BB and lower). This means that they are much more likely to default on their bond payments. And in this case, you as a bondholder will have a higher chance of losing some (up to all) of your invested money.
Inflation Risk
This risk refers to an event where the rate of price increases in the economy basically offsets the returns from the bond. This has the greatest effect on fixed bonds, which have a set interest rate from issuance.
For example, if an investor purchases a 5% fixed bond, and then inflation rises to 10% per year, the bondholder will lose money on the investment because the purchasing power of the returns has been greatly diminished (5% weaker than inflation).
Where to buy bonds in Brunei?
As usual, the places to buy assets like stocks and bonds are bank-linked:
- Baiduri Capital
- BIBD Securities
- Standard Chartered Securities
Types of bonds in Brunei
There are 3 types of bonds you can buy through these places.
1. Wholesale Bond
You can buy wholesale bonds but it requires you to drop a large amount of cash; usually going for about $250,000 for the lot. While you can likely get them at a discounted price (because of purchasing power), the Average Fox doesn’t have that kind of power.
2. Retail Bond
These are more accessible and are traded like stocks on the market. You can buy them through trading platforms and do not need too much capital to invest in them.
3. Bond ETFs
Bond Exchange-Traded Funds (ETFs) mimic the performance of a number of chosen bonds. This could help you spread the risk compared to just picking 1 bond and riding the waves. They do have their own disadvantages such as management fees; someone has to pick and match these bonds, you know. These are also accessible through trading platforms.
4. [Bonus info] Sukuk bond
Here’s something interesting: Brunei’s monetary authority, AMBD has been issuing bonds known as “Short-Term Sukuk Al-Ijarah Securities” since 2006. These can be simply thought of as Syariah-compliant/Islamic bonds. Not much is known about sukuk so far; especially who can buy them and from where. But when I get more information, I’ll be writing more to explore on this.
For now, it’s sufficient to just understand that the Brunei Government itself is issuing bonds. And according to Oxford Business Group, “Short-term sukuk have been a major contributor to the country’s development”.
“…the Brunei Government has thus far issued over BND 12.06 billion worth of short-term Sukuk Al-Ijarah securities since the maiden offering on 6th April 2006” – AMBD, 159th issuance of Sukuk Al-Ijarah, July 2018
Conclusion
Investments in bonds are very attractive to people who are more interested in protecting their principal capital i.e. conservative investors. It’s also usually used as a diversification tool for stock investors too to limit their risk exposure on the market. It’s common to see a portfolio that has stocks and bonds at various percentage holdings. That being said, knowing the risks involved and possible returns for any investments is very important.
Do your homework and invest wisely, Readers! What are some good bonds you have found?
Low risk does not mean no risk.
