Your 3-Step Guide to Stable Income with Retail Bonds!

Receive a stable stream of income while preserving your capital!

With financial markets off to a bad start in 2016, few assets have remained unscathed in the current market turmoil. Where can investors hide?

Rather than hiding under a rock and awaiting a return to financial market normalcy, the SGD retail bond market can offer some solace for more risk-averse investors at this juncture. While investment returns are generally uncertain for financial assets like stocks, an investment in a bond comes with a fixed return - you'll know exactly how much you will earn on your investment and when you'll get your pay-outs. This makes an investment in a bond "boring", although boring seems to be a good thing when you're looking for investment stability!

Let's explore how we can use retail bonds to create a stable stream of income, even as we strive to preserve capital, working on the basis of a S$10,000 portfolio.

Step 1: Select your "fixed return" assets

Table 1: Retail bonds

From the universe of retail bond market in Singapore (see Table 1), we'll choose our "fixed return" assets to construct a portfolio which can generate a stable stream of income. As with any investment, there is a trade-off between risk and reward, so more credit-worthy firms like CapitaMall Trust and Frasers Centrepoint Ltd offer lower yields, while "high yield seeker"-type bonds like those of Oxley, Aspial and Perennial Real Estate Holdings sport the highest yields. For diversification of credit risk, we'll include a combination of both types of bonds (high yield seekers as well as stable income seekers) in our portfolio. The overall yield will be lower, but we will be able to sleep more soundly at night!

So what can we buy for our S$10,000 portfolio?

First, let's consider a higher quality name like CAPITA 3.080% 20Feb2021 Corp (SGD) - the bonds are issued by CapitaLand Mall Trust, Singapore's largest REIT the owner of iconic malls like Plaza Singapura, Junction 8, IMM and Bugis Junction. While the yield on this bond is low (at around 3%), its role in the portfolio is to provide stability rather than strong returns.

We'll also select the FCLSP 3.650% 22May2022 Corp (SGD)s, which are issued by Frasers Centrepoint Limited, a real estate firm listed on the Singapore Exchange with a market capitalisation in excess of S$4b at the time of writing. The company is an international real estate firm with developments in Singapore, China and Australia, and is also the sponsor for three REITs listed in Singapore. Currently, the bonds yield around 3.8%, providing a decent level of yield, albeit with a slightly longer maturity (the bonds mature in May 2022).

After selecting two "stable income seekers", let's consider a higher-yielding bond from Perennial Real Estate, the PREHSP 4.650% 23Oct2018 Corp (SGD). While Perennial Real Estate Holdings is a fairly new real estate firm, the company is backed by strong sponsors who also own over 75% of the firm. This bond sports a decent 4.73% yield at the time of writing, which can help to lift the overall portfolio yield.

Step 2: Size your bond allocations

Having selected our three "fixed return" assets, the next step is to size the bond allocations to create our portfolio. You generally have a fair bit of flexibility in deciding a suitable allocation, depending on whether you're looking for stronger returns (perhaps 80% in HY seekers) or if you have a stronger focus on capital preservation (80% in Stable Income Seekers?). As a rule of thumb, we'll utilise a slightly more conservative positioning, keeping 60% of the portfolio in Stable Income Seekers while placing 40% in High Yield Seekers.

Table 2: Our S$10,000 portfolio

Table 2 shows our portfolio allocation into the three selected bonds, but this is based on "nominal" value. Since we're dealing with bonds, the actual transacted amount will depend on both the market price of the bond as well as the amount of accrued interest on each bond. If the bond is trading at or above par (100), the likelihood is that the actual investment amount will be slightly more than the bond's principal (nominal) value.

Table 3: Estimating accrued interest

Table 3 shows how we can estimate the amount of accrued interest for a bond. For the PREHSP 4.650% 23Oct2018 Corp (SGD), the bonds first started accruing interest on 23 October 2015 (the bond's issue date), which represents around 91 days of accrued interest. To estimate the accrued interest at this point of time, we'll divide 4.65% by 365 days and then multiply that by 91 days, which gives us 1.16%, or S$1.16 per S$100 of par value. Alternatively, you can use the Bond Calculator feature on the bond factsheet page, which provides an "indicative accrued interest" dollar value for each bond.

Based on our intended allocations for the S$10,000 portfolio (and due to the three bonds being quoted below par value at present), we find that the cost of transaction (as shown in Table 4) is actually just S$9,979.21, even lower than our S$10,000 intended investment, even including the 0.35% transaction fee.

Table 4: Estimated Cost of Investments

Step 3: Sit back and enjoy your coupons!

After having executed our investments, all that is left to do is to sit back and enjoy your regular coupons! Table 5 shows the future cash-flows from our S$10,000 portfolio, which actually amounts to a S$1,798.74 total profit based on the difference between the positive and negative cash-flows for the portfolio. For those who want to calculate the actual yield-to-maturity for such a portfolio, the internal rate of return (which can be calculated via the XIRR function in Excel) for the cash-flows shown in Table 5 is 4.05%. To be more precise, you can deduct the 0.2% annual administrative fee from this figure which gives you a 3.85% net return, after considering all fees involved.

Table 5: Bond portfolio cash-flows

Interest payments along with the return of principal upon bond maturity are legal obligations of the issuer - With your retail bond portfolio, you now have a stable stream of cash-flows which won't fluctuate or change with financial market conditions!