When selecting a suitable bond for investment, it is important to understand the differences between the various types of bonds available for investment. With knowledge of different bond categories, investors can have a more realistic expectation of investment returns as well well-border-primary as a better understanding of the various risk factors involved with each bond investment. In this article, we highlight some of the features of several key categories of bonds:
- Developed Sovereign Bonds
- Quasi-sovereign Bonds
- Investment-grade Corporate Bonds
- Non-investment grade Corporate Bonds
Developed Sovereign Bonds
What are they?
- Usually refer to government-issued bonds from countries which have high levels of economic stability
- These bonds are usually accorded some of the highest credit ratings from the three main credit ratings agencies (S&P, Moody’s and Fitch Ratings)
- Examples include US Treasuries, Singapore Government Securities, Hong Kong Government Bonds
- Their bond yields form the basis for Risk-free rates for investors in their respective countries
What kind of returns can I expect?
- Lowest yields, compared to other bond segments
- US 10-year Treasury yield was around 2% while the 5-year Singapore Government Bond had a yield in the region of about 1.5% (data as of 16 Feb 15)
What risks should I be mindful of?
- Generally free from default/credit risk, but interest rate risk is still an issue for longer-maturity securities
- Suitable for investors who want lowest risk bonds as fixed deposit alternatives which can provide a source of stable income
Quasi-sovereign Bonds
What are they?
- “Quasi-sovereign” entities are those which have the support of the government, like government agencies for example
- The different levels of implied government support can result in differing yields for quasi-sovereign bonds, even for those of similar maturities ; credit ratings agencies tend to take this into account when assigning credit ratings to quasi-sovereign entities
- Examples of quasi-sovereign issuers could include Singapore’s Housing Development Board (HDB), one of the country’s sovereign wealth funds (Temasek Holdings), or Hong Kong’s Kowloon Canton Railway Corp
What kind of returns can I expect?
- The segment is generally characterised by low yields, similar to their sovereign counterparts
- As an example, Hong Kong’s Kowloon Canton Railway Corp’s AAA-rated 5.125% May 2019 USD notes had a yield of about 1.9% at the time of writing
What risks should I be mindful of?
- Generally free from default/credit risk, but implied government assistance is rarely tested; interest rate risk is still an issue for longer-dated securities
- Suitable for investors who want lower risk bonds which can offer marginally higher yields compared to government bonds
Investment-grade Corporate Bonds
What are they?
- These are bond which are issued by companies which have superior financial standing, which implies a better ability to service debt
- They have ratings from AAA to BBB- (S&P rating scale), or Aaa to Baa3 (Moody’s)
What kind of returns can I expect?
- Differing levels of yields, depending on whether the corporate bond is closer to AAA (highest possible rating) or BBB- (just one notch away from “junk”, or “non-investment grade”)
- As an example, Nestle’s AA rated Oct 2017 AUD bonds had a yield of just 2.05%, while BBB- rated Far East Horizon’s Dec 2016 USD bonds yielded between 4.74/5.14% (as of 16 Feb 15)
What risks should I be mindful of?
- As opposed to Sovereign bonds (or even quasi-sovereign bonds), credit risk is an issue – there is the risk that an issuer could default leading to an impairment on the bond investment
- Investors have to be mindful of interest rate risk, which can affect the performance of longer-maturity securities
- Investors can usually find a good mix of lower and higher-yielding names in the investment-grade corporate space, which can offer differing risk-reward profiles
- Suitable for investors who want to take on some credit risk in exchange for higher yields
Non-investment Grade Corporate Bonds
What are they?
- These are issued by corporations which are less credit-worthy, usually by smaller companies as opposed to industry bellwether corporations
- These bonds are accorded credit ratings of BB+ or lower (S&P), or Ba1 or lower (Moody’s)
- Sometimes known as “high yield bonds” or “junk bonds”
What kind of returns can I expect?
- Highest yields, compared to other bond segments; returns may sometimes be described as “equity-like”
- As of 4 Mar 15, US High Yield bonds sported a yield of 6.35%, while Asian real estate bonds (dominated by non-investment grade issuers) had a yield of 7%; specific securities like Evergrande’s 2020s currently sport a yield-to-maturity in the region of 12%
What risks should I be mindful of?
- Default/credit risk is the main issue, given the lower-quality nature of the issuers; for troubled companies, default may be avoided via a restructuring, which may see bond investors take a write-down on their investment
- Bond price volatility can be fairly high
- Interest rate risk is less of an issue, since non-investment grade corporate issuance is usually of a shorter maturity
- A large amount of non-investment grade corporate issuance tends to be in USD; investors who do not use the USD as a functional currency may be exposed to potential currency risk
- Suitable for investors who are looking for some of the strongest potential returns in the fixed income space, and are willing to accept a higher level of risk in their investments
The Research Team is part of iFAST Financial Pte Ltd.