Introduction to US Corporate bonds investment . Part 1

Introduction

The objective of this blog is to provide information for Singaporean investors with alternate source of passive dividend and interests from overseas financial market.

With the debacle of Clob shares, S-Chips, penny stocks collapse in SGX over the last 25 years, many retail investors are turning to fixed income investments which generally pay a return on a fixed schedule with protection to their principle capital. Individual bonds may be the best known type of fixed income security, but the category also includes bond funds, ETFs, FDs, and money market funds. The attractiveness of  bonds investing is that they have a much longer terms than fixed deposits, locking in an attractive interest rate. Bonds usually pay semi-annual or quarterly (for baby bonds). This enable fixed income investors to ladder their bonds investment to receive predictable payout throughout the year.

However, in recent years, Spore has also seen many financial debacles with  bonds default from Noble, Ezion, Swiber, Ezra , hyflux, Trikomsel ,Pacific Andes and the list goes on. As you can see, many bonds listed in Spore are of poor quality and are considered as junk bond. There is no proper credit rating for these Spore bonds and it is very difficult to assess the credit worthiness for these bonds.
Another couple of issues with Spore bonds are :
1) Most listed are wholesale bonds with minimum of 250K per lot trading at OTC bond market. It is very difficult to diversify your risk,unless you have several millions to invest.
2) Lack of liquidity.If you are a small timer buying retail corporate bonds on bondsupermart or your broker, I would think you have to worry about liquidity. If you are big timer, your RM in premier/private bank would be in a better position to serve you and can even arrange for meetings with their bond traders. Bondsupermart/FSM charges you 0.20% platform fee for bonds. Premier/private bank normally charge a high commission. In fact, as a small timer, one should not even think of buying bonds because he will not be able to buy a diversified portfolio of bonds. One or two bonds are too concentrated unless he really knows what is doing.
 3) Pricing is not opaque and often you have to rely on your bank relationship manager or brokerage bond desk to put up the bid and ask price. Excessive charges for buying bonds in Spore.. Example:
Fundsupermart charges
1) 0.35% buy and 0.35% sell on nominal value of bond
2) 0.05% per quarter on market value of bond

As for banks or brokerage charges, fee varied
Just sharing someone recent experience of buying OTC bonds from broker and local banks:
1)Broker: $100 + 0.25% + transfer to CDP
2)Bank A: $101 All-in + Free custody
3)Bank B: Put your own bid from $100  + Free custody
4)Bank C: No reply (Either RM was lazy or not interested as he is a very small player)

All investment has risk we have to acknowledge that. But bonds are less risky than equities because they guarantee your principal upon maturity. Only risk for bonds is their default risk before maturity. Of course one can cite special cases of unrated junk bonds defaulting but that doesn't remove the fact that a bond allocation makes your overall portfolio more resilient and more palatable to risk. I do recommend buying at least investment graded bond which is BBB rated and above for newbies.
I would advise Singapore investor to forget about buying corporate bonds for investment in Spore. There is just too much transaction cost and not much choice. I rather buy US Corporate bond using online Interactive Broker (IB). In general, US corporate bonds have higher yield for the same rating.

The case for diversifying into US Corporate bonds investment: 


1) US bonds market is as large as its equities market.  There are over 10 of thousands bonds available in US markets which give fixed income investors choice to select investment best suited for their risk appetite. 

2) High liquidity as US bonds market is a trillion dollars market.

3) Transparency as price quote are listed real time in any online US brokerage. USA bond market is quite efficient. I tried to compare 3 HSBC bonds with different coupon payments and slightly different maturity date, all give around the same yield.

4) Bonds trading cost is as low as $1 to $10 on Interactive Broker (IB).

5) Minimum investment can be as low as $1000 or $25 (for baby bond) . This help to diversify and minimize risk from a single point of failure like losing $250K from a single OTC bond issue in Spore.

6) 3 US Credit rating agencies from S&P, Moody and Fitch to assess bond credit worthiness compare to Spore bonds which mostly have unrated (NR) credit rating.

7)Best of all, there is no US withholding tax for US corporate bond interest payment to foreigner. US Corporate bond pay interest, if you are a US citizen, you paid that interest as part of your US income tax but as a foreigner you don't pay US income tax and you are not liable for that interest earned from bonds. Basically a Bond is a debt. If a US corporation wishes to borrow money from a foreign entity. The foreign entity need not pay tax on the interest. If withholding is imposed, it makes it more difficult for US corporations to borrow money.

Risks in US Corporate bonds:

1) Forex loss. However, this can be double-edge sword that you can get forex gain if the exchange rate become favorable when you redeem your bond or your bond mature.

2) Interest rate increase will decease the value of your bonds. This is also true for any other investment like stock and property. Your bond will still return back to par value upon maturity so bond is not suitable for trading.

3) Little or no capital gain expected  unless you bought your bond way below par value. For example, some 10 years A investment grade bonds from Google and Microsoft yield less than 3%. If you have used that capital to buy the shares instead 10 years ago, it would have returned a few hundred percent compare to less than 30% return from bond interest.


How to get started for investing in US corporate bonds?

Before you start, here are some questions you might be asking:

1. Normally which corporation bonds are you looking at?
2. What ask yield is considered normal on USA market?
3. Is it worth to go for perpetual bond since it doesn't have any maturity date? I notice most perpetual bond has higher yield to ask compared to non perpetual bond offered by same corporation.

To answer these questions , a good link to do your research will be using Morningstar bond center website

http://finra-markets.morningstar.com/MarketData/Default.jsp

Here are some criteria that I will be looking at when I am using the advance search function to look for  bond investment that suit my requirement:
1)Coupon and Interest
2)Maturity Date
3)Ratings and Credit
4)Calls and Options
5)Trade Parameters Date and Price
6) Yield to Maturity, Yield to Call and Yield for worst (for bonds that past callable date and can be called anytime)

I used bond ladder method to buy a list of bond (> 30) so yield can be as low as 2-3% for A grade or better to short maturity bond that yield close to 8% for Non-rated bond or long maturity bonds with higher yield ( they can mature for as long as 2075 and they are almost equivalent to perpetual).
For bond investment, I will start with investment grade bond (bbb- and better rating) with less than 10 years maturity. For these type of bonds, you probably can find something between 4.5 to 5.5 %. I am good with this yield because the best FD and 5 year insurance I can find in Spore are less than 2.5% .I can also use the 10 year US treasury yield as benchmark. They are around 2.6% for 10 years. Therefore, if my bond yield is double than that, I can good with it.
It is not worth looking for perpetual bond to invest since interest rate increase will cause its value to go way below par. However, there are many US corporate bonds that matured in 30 years or longer that you can invest if you are hungry for yield.

In my next article, I will elaborate more on how to use the advance search tool for selecting US corporate bonds and building a bond watchlist.