Assessing bonds in a volatile market
Market volatility has seen investors shift towards bonds as a safe-haven asset, but one investment firm has advised investors to consider multiple factors before “jumping on the bond bandwagon”.
According to FIIG Securities, bonds are proving attractive to investors because they are obliged to “repay at par” upon maturity, regardless of current trading value.
However, FIIG head of research Thomas Jacquot has said investors need to consider more than just the return before breaking into the bond market.
Mr Jacquot said investors first need to consider the “survivability” of a company to see whether or not the company would be able to survive for the term of the bond.
He also said they need to understand where the bond sits in the capital structure as that “will determine the order of payment if the company is wound up”.
“In the event of a wind-up, subordinated debt, hybrids and shares that rank below senior debt must be wiped out completely before bondholders would incur a loss,” Mr Jacquot said.
It is important for investors to know before purchase whether or not a bond is fixed, floating or inflation-linked, said Mr Jacquot.
“Fixed rate bonds will have a fixed schedule of payment over their life and will not change,” he said.
“Floating rate bonds will have their interest payment determined on each payment date, usually quarterly, by reference to a particular benchmark such as the BBSW in Australia.
“The key difference between fixed and floating rate, other than the fluctuation in interest payments, is that the price of fixed rate bonds is a lot more sensitive to interest rate movement. When rates go down, the price of a fixed rate bond will go up.”
Mr Jacquot advised investors check the bond’s term to maturity, determine if they can actually buy the bond and assess the bond’s return given the risks as “every bond and company has risks”.
He said checking if a bond has a credit rating will give an investor an indication of the risks involved, noting that a higher credit rating normally means a lower risk.
Investors should also check the size of the issue as the larger the issue, the greater the likely liquidity, Mr Jacquot said.
Mr Jacquot believes it is important for investors to assess the relative value of bonds to other company investments and when compared to other bonds from similar companies.
He said investors should ask themselves the following questions:
- What returns are available on other investments?
- Does the company issue senior secured or subordinated debt?
- Is the return on the senior bond what you would expect, given returns on these other investments?
- What rates of return are available from companies in the same sector or similarly rated companies?
“This list will help you determine if a bond is suitable for your portfolio and can be used to ask your broker questions,” Mr Jacquot said.