Introduction to Bonds
The Malaysian Bond Market Landscape
Malaysia’s bond market has grown leaps and bounds over the past three decades from an outstanding amount of RM 66 billion in 1992 to RM 1.68 trillion as of 2nd June 2021, equivalent to an annualized growth rate of 12.06% per annum.
The sovereign market (including quasi-government issued debt) accounts for more than 69% of the total bonds outstanding, with corporate credit making up the rest. These corporate bonds are issued from various sectors such as the financial sector, property development, construction, and oil and gas.
From the RM 1.68 trillion bonds outstanding, RM 1.06 trillion of these fixed income instruments consist of sukuks while the rest are conventional bonds. Sukuk is a shariah-compliant financial instrument similar in characteristics to conventional bonds.
Given such a proportion of sukuk in the local market, it should come as no surprise that Malaysia is also home to the largest sukuk market in the world, accounting to more than 39% of total global sukuk issuances in 2020, ahead of Saudi Arabia (20.4%) and Indonesia (17.5%).
Closer to recent times, Malaysia’s sovereign bond market’s attractiveness has proven its value in the global fixed income market. Despite the global low interest rate environment which has seen the central bank of Malaysia, Bank Negara Malaysia (“BNM”) cut interest rates 3 times in 2020 to drive interest rate at an all-time low of 1.75%, foreign holders of local sovereign debt – comprising of both the Malaysian Government Securities ("MGS") and Malaysian Government Issued Instrument ("MGII") – have been net buyers for 12 months in a row from May 2020 to April 2021. Much of this is due to the fact that Malaysia still offers one of the highest interest rate differentials in comparison to US Treasury bills across the region which has driven foreign investors hunt for yield.
What are bonds?
Bonds are debt instruments issued by corporations or government, of which, a bond investor is the lender to the issuer. From another perspective, when individuals acquire financing from banks, banks in return receives interest plus the principal lent. Bonds work in a similar way whereby the issuers are essentially the borrowers and lenders are investors. Investors in return receive fixed payment of interest (coupon).
The above diagram can be explained as follows:
- From an issuer’s (borrower) perspective here, they are looking to borrow monies from the investors (lenders). The lenders will 1) lend out their money, and 4) receive periodic interest payments by the issuer.
- Monies raised are usually used by issuers to fund for A) project developments, B) capital expenditure, or even C) to repay existing loans that will be due soon (refinancing). These funds allow the issuer manage their liquidity better.
- The amount of interest paid to lenders are usually generated from projects or even using existing cash flows to meet the financial obligation. Upon maturity, the lenders would have received their interest over the period of the bond plus their principal amount, provided that the issuer meets their financial obligation.
- For example, John purchases a bond of $1 million that matures on 1st January 2040 from a corporation at a coupon rate of 2.8% per annum. From John’s perspective, he is now the bondholder, and receives 2.8% interest payment of the face value from the corporation every year until maturity. From the company’s perspective, upon receiving the funds, they will utilize the funds by John to fund their business at the same time paying interest to John every year. At maturity, the corporation will pay John the face value (debt value).
Fundamentals of Bonds
A bond name would typically look something below:
Bond Name: Short Name of Issuer Name
i.e. Malaysian Government Securities (MGS)
Coupon
While putting your money with banks generate you interest, bonds do payout interest as well. The coupon rate of a bond is the interest rate that the issuer agrees to pay each year until the maturity date, quoted in annual rate. The coupon rate is calculated by multiplying the coupon rate with its par value.
Assuming a bond paying 5% coupon per annum, based on invested nominal value of MYR 10,000, investors get a yearly coupon of MYR 500.
Maturity Date
The maturity date of a bond is the date when the issuer is legally obligated to repay the debt and is done by redeeming the bond by paying the outstanding principal amount. In short, it is the expiry date of a bond.
Type of Issuer
The issuer of the fixed income instrument is effectively the borrower, whereas the investor (bondholder) has the role of the lender.
Corp: Corporation
Govt: Government
Currency
Issuers may require foreign currency to fund their business, hence, raising bonds denominated in foreign currency. (i.e., USD bonds, CNH bonds)
Why have bonds in your portfolio?
1) Fixed Income
Bondholders enjoy fixed payments regularly until the bond matures, which is a form of passive income. This is especially important for retirees or the unemployed.
Furthermore, having a fixed income stream and the timing certainty of cash inflows enables investors to manage their finances and investments better.
2) Capital Preservation
Unlike stocks, there is certainty in the amount to be received upon maturity. An ideal capital preservation portfolio should have at least some allocations to bonds.
3) Diversification
As opposed to stock investors, bondholders are paid first in the event that a corporation encounters bankruptcy. Bond prices are less volatile compared to stocks, which means investors can use bonds to diversify portfolios and manage their investment risk. However, it all still relies on the credit selection of the bond that investors put their money in, i.e., high risk, high return.
4) Less Correlation with Other Asset Classes (i.e., stocks)
The relationship between stock and bonds tends to be weak when inflation and growth are low.
i.e., During a recession, people tend to prefer to have a steady cash flow. Demand for bonds increase, driving prices up, vice versa.
Who can invest in bonds?
In the past, bonds can only be purchased by Sophisticated Investors or Accredited Investors. Participation in bonds and sukuk(s) was then extended to retail investors when the Securities Commission of Malaysia (SC) introduced relevant guidelines (i.e. Guidelines on Issuance of Corporate Bonds and Sukuk to Retail Investors and Guidelines on Seasoned Corporate Bonds and Sukuk). Hence, this has provided a number of avenues for retail investors to invest directly in retail fixed income assets (e.g Exchange Traded Bonds and Sukuk / Seasoned Bonds) for the purpose of portfolio diversification.
Exchange Traded Bond and Sukuk (ETBS)
ETBS are fixed income securities, also known as bonds or sukuk*, that are listed and traded on the stock market. ETBS are issued either by companies or governments (the issuer) to raise funds for their needs. ETBS have varying structures such as fixed rate, floating rate and hybrids.
* Sukuk refers to issues that comply with Shari'ah principle
Why Invest in ETBS?
Here are some of the reasons to invest in ETBS:
- Additional Income Stream: Investors can benefit from a steady income stream through regular coupon payments.
Seasoned Bond Framework
In 2019, the SC launched the Seasoned Bond Framework to facilitate the distribution of over-the counter (OTC) corporate bonds or sukuk (bonds) that were originally meant for to sophisticated investors in the primary market, to retail investors in the secondary market. Bonds that can be traded in smaller pieces have to meet specific criteria in order to be deemed as a Seasoned Bond.
Read here for more info on the Seasoned Bond Framework by SC.
How can investors earn from investing in bonds?
While investing in bonds, there are 2 components to take into account.
- Coupon (Fixed interest paid out to investors):
A fixed portion of interest expressed as a percentage of the bond’s face value.
For example: 5% coupon rate per annum on face value of MY 100, equates to a MYR 5 interest per annum.
- Potential Capital Appreciation:
When purchasing bonds, investors not necessarily have to hold a bond till maturity. When a bond price increases, an investor can sell off their bond, profiting from the change in price.
Other useful resources:
Common Jargon for Bonds
Your Cheat Sheet to Common Terms and Jargon for Bonds:
Is it still a good time to invest in bonds in 2021? And Why?
Medium to long duration Malaysian bonds the sweet spot as BNM prolongs low interest rates:
Misconceptions About Bonds
Bond Investing Myths:
https://secure.fundsupermart.com/fsm/article/view/10106/bond-investing-myths
Disclaimer:
The information in these articles are for general information purposes only and is provided on an “as-is” basis without any representations or warranties of any kind. The information does not constitute legal, financial, trading or investment advice. You are advised to seek independent advice and/or consult relevant laws, regulations and rules prior to relying on or taking any action based on the information presented. In no event shall Bursa Malaysia Berhad and its subsidiaries and iFAST Capital Sdn Bhd be liable for any claim, howsoever arising, out of or in relation to do not accept any liability for the information provided in these articles, (including but not limited to any liability pertaining to the accuracy, completeness or currency of the information,) and for any investment or trading decisions made on the basis of the information.
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