Yield Hunters, find out how to potentially boost your income yield through FSMOne Bonds Financing!

Bonds are fixed-income instruments that require the issuer to make specified interest payments to the bond investor at regular intervals, with the full principal repayment at par value upon bond maturity. The Yield-To-Maturity (YTM) represents the annualised rate of return or yield earned by investors if held through maturity.

 

If you have read our previous article on JPY positive carry , you will understand the concept is similar. To recap, positive carry is a margin strategy where the income generated from the investment (e.g. 7% p.a.) is higher than the cost of borrowing (e.g. 4% p.a.) to allow investors to potentially profit from the difference (3% p.a.).

Here’s a version for Bonds Financing:

 

Bond investors who are looking to invest in a full-lot bond (e.g. SGD 250,000) will be excited to find out that they could potentially increase their yield through financing. For instance, a cash investment of SGD250,000 into ESRCAY 5.65% Perpetual Bond (SGD) offers a Yield-To-Call (YTC) of 7.23% (as of 20 August 2024). 

By purchasing an additional full-lot bond using Margin and using the initial bond as collateral, the investor can increase their potential yield without additional capital outlay. With a bond yield of 7.23% and SGD margin interest at 4.95%, the investor gains an extra 2.28%, boosting the total yield to 9.51% p.a. with an initial capital of SGD 250,000.

Below is an example that illustrates the income breakdown:

Capital Outlay	SGD 250,000
Investment Amount	SGD 250,000
Bond Yield to Maturity/Call	7.23% p.a.
Potential Net Income Per Annum	SGD 250,000 x 7.23% = SGD 18,075
Return on Investment (ROI)	18,075/250,000 = 7.23%

 

Capital Outlay	SGD 250,000
Loan Amount	SGD 250,000
Total Investment Amount (with Financing)	SGD 500,000
Bond Yield to Maturity/Call	7.23% p.a.
Potential Gross Income	SGD 500,000 x 7.23% = SGD 36,150
iFAST Margin Rates @ SGD 4.95%** on SGD 250,000 Loan	SGD 250,000 x 4.95% = SGD 12,375
Potential Net Income Per Annum (Less Financing Charges)	SGD 36,150 – SGD 12,375 = SGD 23,775
Return on Investment (ROI)	23,775/ 250,000 = 9.51%

Now that you're familiar with bond financing, you might be tempted to invest. But before you dive in, let’s explore another alternate bond financing approach:

The example earlier demonstrates using margin to finance the purchase of the same bond. In a cross-bond financing scenario, investors can choose to finance the purchase of a different bond in a different currency, thanks to FSMOne’s multi-currency margin facility. This feature allows investors to draw down in currencies like GBP directly, eliminating the need to convert their existing cash solutions.

For example, after a client invests USD 500,000 into a USD-denominated bond (using cash as payment method), investors may choose to leverage in a GBP-denominated bond as a form of diversification to diversify their coupon payments in different currencies—USD (US$) and GBP (£)—assuming the second bond purchase is in a different currency. 

 

	Bonds	Source of Capital	Investment Amount	Bond’s YTM/YTC	Gross Income /Year	Financing Charges /Year	Potential Net Income /Year	Net Yield Earned
1	FWDGHD 8.4% 05APR2029 (USD)	Own Capital	US$500,000	7.52%	US$37,600	-	US$37,600	9.00%
2	GBP bond	Margin Purchasing Power	£350,000 (Loan)	7.51%	£26,285	£350,000 x 5.90% = £20,650	£26,285- £20,650 =£5,635 £5,635 @ GBP/USD= 1.3189 (as of 26 Aug 2024) = US$7,432
Total							US$44,993

After opting in for Margin, you will be able to view the respective Loan-to-Value (LTV) Ratio for each bond listed on FSMOne under Bond Factsheet. The LTV would determine your margin buying power, where you would be able to view this figure by selecting Margin under Payment Method in the Order Cart page. The margin buying power reflected is universal, where it will automatically be converted to the investment currency you are purchasing (e.g. USD-denominated bonds -> USD Margin).

   

In general, bonds are considered less risky than equities because their par value is guaranteed at maturity. Additionally, investors receive fixed interest payments, and historically, the bond market has proven to be less volatile compared to other asset classes.

However, lower risk does not mean no risk. Different types of bond investments come with varying levels of risk. For example, corporate bonds carry a higher degree of default risk, which often results in higher coupon rates compared to government bonds which typically have a lower risk level.

1.       Default Risk

There is a possibility that bond issuers might default and be unable to meet their obligations on time, which is especially true for high-yield or junk bonds that carry higher risk of default. These bonds are typically non-marginable on FSMOne, so the selection criteria for financing would be more stringent.

The credibility of the issuer is crucial when selecting the bonds to leverage. Our FSM research team have previously initiated coverage on reputable issuers such as ESR-Group, Barclays PLC, & FWD Group, ensuring that the bond issuers are financially sound and offer attractive propositions. We have provided some summary points of these issuers at the end of this article for reference.

2.       Interest Rate Risk

Bond pricing and interest rate typically have an inverse relationship. When interest rates rise, bond prices typically fall, and borrowing costs may increase. Conversely, when interest rates decline, bond prices generally rise, and borrowing costs may decrease.

Therefore, borrowing money to leverage in bonds during a rising interest rate environment could potentially be a double whammy for investors due to falling bond prices (unrealised mark-to market losses) and higher margin financing charges due to the rise in interest rates.

For investors who are currently anticipating market interest rates to fall, bond investments may currently be more attractive to benefit from the potential capital appreciation (due to bond prices increasing), where they can sell their bonds in the secondary market to realise the capital appreciation without holding it to maturity. In addition, a declining interest rates environment would also possibly reduce the margin financing charges.

3.       Market and Liquidity Risk

Bonds are traded over the counter (OTC) between brokers. Illiquid bonds can be challenging for investors to sell before maturity and often come with wider bid-ask spreads. The lack of marketability during urgent situations can lead to liquidity risk. FSMOne offers Bond Express which allows you to trade a selected list of wholesale and retail bonds with firm executable pricing and volumes, mitigating the liquidity risks mentioned earlier.

Related articles;

• • https://secure.fundsupermart.com/fsmone/article/rcms288906/credit-update:-barclays-%E2%80%93-no-need-to-panic
• • https://secure.fundsupermart.com/fsmone/article/rcms292680/idea-of-the-week:-more-attractive-than-sg-t-bills-look-no-further
• • https://secure.fundsupermart.com/fsmone/bonds/factsheet/USG37049AB20/FWDGHD-8-400-05Apr2029-Corp-USD-
• • https://www.fwd.com/en/newsroom/press-releases/FWD-Group-announces-2023-financial-results/

Disclaimer

The use of margin involves a high degree of leverage and risk which can lead to losses as well as gains which are of a larger magnitude as compared to the movement of a security or market.

Investment products involve risk, including the possible loss of the principal amount invested. Past performance is not indicative of future performance and yields may not be guaranteed. All materials and contents found in this advertisement are strictly for information purposes only and should not be considered as an offer or solicitation to deal in any capital market products.

You should therefore carefully consider whether such a financing arrangement and/or investment products you are purchasing is suitable for you in light of your own financial position, experience, objectives, ability to bear risks and other relevant circumstances.

If you are uncertain about the suitability of the product financing and/or investment product, please seek advice from a financial adviser, before making a decision to use the product financing facility and/or purchase the investment products.

While iFAST Financial Pte Ltd and/or any of its third-party providers has/have tried to provide accurate and timely information, there may be inadvertent omissions, inaccuracies, and typographical errors. Opinions expressed herein are subjected to change without notice. Please read our full disclaimer in the website.

This advertisement has not been reviewed by the Monetary Authority of Singapore.