A safe haven?

Bonds are issued by governments or companies, known as issuers, to raise funds for specific projects and/or their operations.

When you invest in bonds, you are effectively lending money to the relevant government or company for a fixed period in return for periodic coupon or interest payments at regular, predetermined intervals. You will also receive your principal due when you hold the investment to maturity.

Bonds are usually touted as the safer investment option compared to stocks. In the event of the stock market falling, such fixed-income instruments can reduce volatility and preserve capital as a separate asset class and means of diversification. They also offer more stable and consistent means to generating passive income.

To that end, bonds typically pay out lower returns than stocks in exchange for being relatively safer, contingent on their credit rating. So when companies offer bonds with high yields (usually accompanied by a lower credit rating), it means that the risk for investors is also higher, including the risk of the issuer defaulting on payments. Such high-yield bonds are usually of non-investment grade.

 

Spotting problematic bonds

So how exactly can investors spot problematic bonds? We’ve put together some handy tips:

• Examine the sector these companies are from. Some industries – such as trading, shipping, property development, metals and mining – tend to be riskier than others, given the cyclical nature of their business and lumpy cash flows.

• Track closely the issuer’s financial statements and announcements. For example, does the company have a track record of risky expansions or over-borrowing? Another way to assess an issuer’s creditworthiness is to tap reports by ratings agencies such as Moody’s or Standard & Poor’s, which issue credit ratings that set safe and stable bond investments apart from the speculative.

• Look at how the issuer’s parent company (if any) are doing. The parent company’s credit quality, if negative, could potentially impact its subsidiaries.

• Understand interest rate risks. Interest rates and bond prices generally share an inverse relationship. For example, when yields go up for fixed rate bonds, bond prices tend to fall. In fact, Maybank’s Premier Wealth team believes that with bond yields currently rising in response to tightening monetary policy, investors should carefully review their exposure to assets sensitive to higher interest rates, which are generally assets with a longer maturity. The team sees pockets of opportunity in high-yield credit (where maturities are shorter and credit spread buffers are fatter) as compared to investment grade credit for now, citing upward pressure on government bond yields.

• Keep an eye on external macroeconomic events and developments. An unanticipated plunge in oil prices, for instance, may derail cash flow projections in an oil and gas-related bond, eventually resulting in the issuer’s inability to pay out bond coupons or the principal.

Essentially, buying a bond may seem less risky than buying a stock. But the reality is that every investment comes with risk. Investors should be properly apprised of the risks involved with any investment.