Bond Investment 101

You may be looking for ways to protect your wealth for the long-term or grow it in this challenging economy – such as investing in equities or stocks. But did you know that stocks are not the only instrument that can help you grow your wealth?

Malaysia also has a bond market with both conventional and Islamic offerings, although it is not very well-known among beginner investors. 

Whether you are a beginner investor or more experienced, you’re bound to have some knowledge about stocks. You may be following a stock exchange like the KLSE, where you can discover and learn about stocks to buy – but there is no similar exchange for bonds, so it is more difficult for you to know where to buy bonds and what kinds of bonds are available.

Bond returns are also usually not as attractive as equities, and a larger minimum amount is usually needed to buy a bond. For example, an equity share may cost RM100 each, with an average return of 15% over 10 years – whereas a retail bond may cost RM1000 and pay an interest rate of 5% over the same period. Many investors would prefer to invest in equities so that they could enjoy the better return rate, and they would not have to lock away RM1000 in a bond investment for 10 years.

Moreover, many bond investors are institutional investors (i.e. corporations) so if you are an ordinary individual investor wanting to invest for yourself, you may be intimidated by the idea of buying bonds, especially if you do not know how bonds work.

Bonds may not be as popular or well-known as equities, but they can be a lower risk investment. This is because bonds are a debt security. When corporations or governments need to raise money, they may decide to “borrow” money by selling bonds.

When you buy a bond, you are actually “lending” money to the bond issuer. You’ll be paid a regular interest, and get back the principal amount when the bond matures – a bit like a fixed deposit. You can also profit from bonds by selling them if their value rises higher than what you paid.

It’s important to know what type of bond you’re investing in, so that you can prepare for the risks and benefits. Here are some bonds you should know about:

Government or sovereign bonds: These are issued by the government and are most likely the safest type, because the government is not likely to be unable to pay your interest or repay your investment capital. State governments can also issue municipal bonds. These bonds are usually used to finance public projects and services.

Corporate bonds: offered by large companies to finance their activities. For corporations, bonds are an attractive alternative to taking out a loan from a bank, because interest rates for bonds are usually lower than for bank loans. If you invest in a corporate bond, it’s important to keep track of the company’s performance because there is a chance you may lose money if the company goes bankrupt.

Junk bonds: high-yield, high-risk bonds. Companies that are struggling might issue these. Although these bonds give a high interest, there is a higher risk of the company defaulting, so you may lose money. If the company improves, investors may be able to sell their bonds for higher than what they paid to buy them.

Convertible bonds: With convertible bonds, investors have the option to convert their bonds into a set number of equity shares. You’ll have the flexibility to enjoy the benefits of bonds or of stocks, depending on the performance of the bond’s underlying securities.

Callable bonds: Callable bonds are bonds with a “call” feature that enable the issuers to redeem the bond before it matures (i.e. before the Bond’s end date). When interest rates are lowered, some bond issuers may redeem their bonds as a measure of protection against this. While it can be beneficial to the issuer, bond investors (like yourself) might lose future interest payments and disrupt your portfolio.  

Bonds are long-term investments that provide a regular income, and they carry a lower risk than equities. They can also help to diversify your portfolio.

There is always the risk of default. However, depending on the type of bond, this may not be likely to happen. Aside from default, there are also other risks to consider.

Sovereign risks apply to government bonds. Although government bonds are low-risk, the government can still change its policies on how it repays its debts, which will affect the interest you earn.

There is a chance that after you buy bonds, your issuer may offer new bonds with a higher interest rate than the ones you bought. This is an interest rate risk, and if you were to keep the bond you bought, you could miss out on higher potential earnings.

Your bond’s market value can also be affected by changes in interest rates – if your bond’s interest rate is considered lower than the bonds that your issuer is currently offering, it can be harder to sell your bond.

There is also a call and prepayment risk for most bonds, where your bond issuer may decide to return your principal early, so you will not be able to enjoy interest payments until the maturity date.

Not all risks would come from the bond issuer. When you buy bonds, you put aside a large amount of cash for a long time. Although you would get your principal back at the maturity date, there is a chance that you may need that cash for emergencies before your bond matures. If this happens, there is the risk of not being able to sell your bond, missing out on future interest payments, or having to sell your bond at a lower price.

Also, since bonds are mostly sold over-the-counter, it can be difficult to determine what a good price is, so there is a risk that you may be charged higher than what is fair.

This article is for informational purposes only and CIMB does not make any representation and warranty as to the accuracy, completeness and fairness of any information contained in this article. As this article is general in nature, it is not intended to address the circumstances of any particular individual or entity. You are advised to consult a financial advisor or investment professional before making any decisions based on the information contained in this article. CIMB assumes no liability for any consequences arising from your reliance on the information presented here.