BOND-INVESTING

BOND INVESTING in the PHILIPPINES

Overview

The Philippine Stock Exchange promotes bond investing as a vital economic activity, encouraging individuals and institutions alike to consider bonds for financial growth and diversification strategies. Understanding the various types of bonds, their characteristics, and their potential as investments within the Philippines is essential for informed decision-making.

BONDS (The BASICS)

Definition

Bonds are debt instruments that serve as formal agreements where investors lend capital to borrowers, typically governments or corporations, for a predetermined period in exchange for periodic interest payments and the return of the bond's face value upon maturity.

Obligation

The borrower, known as the bond issuer, is legally required to pay back a specified principal amount to the lender, referred to as the bondholder, at predetermined times throughout the bond's life and at maturity.

Types of Bonds

  1. Government Bonds (Treasury Bonds): Issued by the national government to fund various public expenditures.

  2. Corporate Bonds: Issued by companies to raise capital for expansion, projects, or working capital needs, carrying a higher risk compared to government bonds.

BONDS vs. STOCKS

Key Difference

Unlike stocks, which represent ownership in a company and carry no guaranteed return, bonds offer a guaranteed future payment in the form of coupon interest. While stocks may yield dividends, these are dependent on the company’s profitability and are not guaranteed.

Key Bond Terms

  1. Face Value: This term denotes the amount borrowed by the issuer, which must be repaid at the bond's maturity. It represents the bond's par value.

  2. Maturity Date: This is the end of the loan period when the bond issuer must repay the face value of the bond to the bondholder. Maturities can range from short-term (1 year) to long-term (over 30 years).

  3. Coupon Rate: The coupon rate reflects the interest rate paid by the bond to the bondholder, which can either be fixed (stays constant) or floating (varies based on benchmark rates).

How to Make Money with Bonds

A. Coupon Interest Investors can earn returns through coupon interest, which tends to be fixed for the duration of the bond.

  • Example: An 8% coupon on a bond worth P100,000 yields P8,000 yearly, serving as a predictable income stream for investors.

B. Bond Trading

  • Strategy: Investors often utilize the strategy of "rolling down the yield curve" by purchasing long-term bonds, then selling them after 2-3 years when bond values typically increase due to market conditions and interest rate fluctuations.

Types of Government Bonds

  1. Treasury Bills (T-bills): Short-term securities with maturities of 1 year or less, sold at a discount from their face value (maturities could be 91, 182, or 364 days). They do not offer periodic interest payments; instead, they are redeemed at full face value at maturity.

  2. Treasury Notes (FXTNs): These are medium-term, interest-bearing obligations with a maturity exceeding 1 year, providing fixed-rate returns and trading on secondary markets.

  3. Retail Treasury Bonds (RTBs): Representing long-term investments with maturities of 10 years or more, RTBs offer safe, liquid investments and provide quarterly interest payments, targeted at small investors with a minimum investment of P5,000.

  4. Dollar Linked Peso Notes (DLPN): These bonds have a maturity of 2-3 years and returns are linked to the USD/PHP exchange rates, adding an additional layer of currency risk and potential reward.

Purchasing Government Securities

Institutions Eligible to Purchase

Eligible purchasers include mutual funds, pension funds, banks, corporations, and individual investors. Despite the general belief that government bonds carry minimal risk, investors must remain aware of underlying risks, including interest rate fluctuations.

Securities Dealers

These are licensed entities that engage in the buying and selling of securities on behalf of clients or for their own investment portfolios. They play a crucial role in facilitating bond transactions.

Government Securities Eligible Dealer (GSED)

A GSED is a SEC-licensed dealer who meets specific capital and operational requirements set by the government to participate in bond auctions, ensuring a regulated and transparent trading environment.

Investment in Corporate Bonds

Market Overview

The corporate bond market consists of commercial papers and private bond issuances primarily from larger corporations. The secondary market for these bonds is relatively limited, providing less liquidity compared to government bonds.

How to Invest in Private Corporate Bonds

Issuers of private corporate bonds are typically private corporations, with bonds usually having terms ranging from 2 to 7 years and potentially offering floating interest rates, which are subject to 20% taxation on interest income.

Risks in Bond Investing

  1. Reinvestment Risk: This is the risk of having to reinvest cash flows at lower interest rates, especially if a bond is called or prepaid.

  2. Call Risk: Issuers may choose to call, or redeem, the bond before its maturity, leading to reinvestment of funds at potentially lower market rates.

  3. Prepayment Risk: Similar to call risk, this occurs when an issuer pays back bonds early due to declining interest rates, which can force bondholders to find new investment opportunities in a lower-yield environment.

  4. Inflation Risk: Rising inflation can erode the purchasing power of the fixed interest payments received, reducing the effective return on investment.

  5. Exchange Rate Risk: Investors in foreign currency-denominated bonds face depreciation risks when converting returns back to the local currency, affecting overall returns.

  6. Downgrade Risk: Bonds with deteriorating credit ratings might face increased default risk and experience a decline in market value. Market participants may react negatively to credit downgrades.

  7. Sovereign Risk: This pertains to the risk associated with government bonds wherein shifts in governmental policy or economic capability can impact the government’s ability to honor its repayment commitments.

  8. Event Risk: Unexpected external events (such as regulatory changes or natural disasters) can significantly impact the financial stability of bond issuers, introducing risks that may not be easily quantifiable.

Retail Treasury Bonds Features and Purchase

Characteristics

Retail Treasury Bonds (RTBs) feature fixed interest rates, making them appealing to retail investors. Interest is paid quarterly and the bonds are accessible to investors starting with a minimum investment of P5,000, catering to a broad range of investment profiles.

Purchase Options

RTBs are available during designated public offering periods defined by the Bureau of Treasury and may be limited by prevailing market conditions, emphasizing the importance of being informed about market opportunities.

Conclusion: Why Invest in Bonds?

Bonds tend to provide higher returns compared to traditional savings accounts, accompanied by regular payments and a generally lower risk profile. They are quintessential for diversifying an investment portfolio, enabling investors to manage risk effectively while seeking capital preservation and growth. Investors are strongly encouraged to consider bonds as a practical and viable component of their investment strategies within the Philippines, reflecting on both their individual financial goals and risk tolerance levels.