In the past, we’ve introduced a new means of earning passive income through investing in bonds, which are paper assets that offer investors a chance to get periodic proceeds. This article is going to focus on corporate bonds.
What is a corporate bond?
When a company wants to raise capital, they can do so by giving up equity and selling stocks to more investors. Another way is to borrow money, and they do that by getting loans from banks and other lending institutions. There is also one other option in borrowing, which is to issue corporate bonds.
A corporate bond is a proof of indebtedness. The company declares how much funds it wants to raise, the interest and how often it’s going to be paid, and the length of time that it’s going to settle the debt.
People who buy bonds are called bondholders and they’re effectively the creditors, and the company that issue them is the borrower. They are going to get paid with periodic interest until such time, called maturity, that the company is going to repay the debt.
However, it does not confer fractional ownership of the business to the bondholders like the way stocks do to stockholders. Instead it gives out regular interest payment, and owners of stocks can gain from dividends and the rise of the stock price. In the event that the company closes, however, bondholders have a prior claim to the liquidated value of the company’s assets. That means they would be paid first before the stockholders.
Why do companies issue bonds?
But why do companies borrow money through bonds and what is its difference to bank loans?
Corporations are always on the look-out in sourcing funds at the least cost, so they choose to get the lowest interest rate whenever they do need to borrow money. In a loan, the banks set the interest rate and it can be lower or higher depending on the prevailing market conditions, the chances of default of the company, and other such risks. However, the company sets the interest when selling bonds. Thus, they can find ways to justify giving out an interest that remains to be attractive for investors and is in line with their financial objectives of minimizing cost in acquiring capital.
Secondly, banks have a lot of power in setting up the terms of the loans. They may require specific changes to the business or establish conditions that would oblige the company to settle the debt before maturity. There are no such conditions in bonds. The company is free to set the terms, so they’re less bound to conditions about how the business is run.
Who can buy corporate retail bonds?
Any company that is selling bonds have two options. They can sell them to institutional investors and people of high net worth in a process called private placement. The second method is to offer them to the investing public. Regulatory requirements may be quite stringent, but the advantage is that they are available to more investors. The more people they are offered, the better the chances they are going to be subscribed.
What is the difference between government bonds and corporate bonds?
As their names imply, government bonds are issued by the Bureau of the Treasury and other agencies of the government. Meanwhile, corporate bonds are issued by Philippine corporations duly regulated and certified with secondary license by the Securities and Exchange Commission.
What are the basic features of a corporate bond?
So when a company is going to go to the public to source funds by issuing bonds, the announcement usually published in major newspapers, their regulatory disclosures, and media outlets. The public can then reach out to selling agents (a selling agent is a bank or a company that is authorized to take orders or subscriptions). Here are some of the common features that you’re
- Minimum amount
- Increment amount
- Coupon or interest
- Offer date
- Issue Date
- Maturity Date
- Credit rating
On the other hand, an increment amount is the least that you can add on your investment if you want to subscribe more than the minimum amount. As an example, the Arthaland green bonds has an increment of ₱10,000 while the BDO bond has an increment of ₱50,000.
Coupon or interest is the company’s payment in exchange of borrowing your money. It is expressed in percentage of your capital annually, and it is dependent on many factors. Generally, the longer the tenor the higher the interest is because of the risk posed by the number of years before the debt is settled. Other such risks include the likelihood of defaulting on interest or capital payments, the economic/capital market conditions, the financial position of the company, etc. The interest that you earn is subject to 20% capital gains tax.
Frequency describes how often in a year you’re going to get the interest. It is usually paid out quarterly (every three months).
The offer period is the range of dates that the bonds are available to be subscribed. Outside of this range, investors can purchase them through the secondary market, the Philippine Dealings and Exchange Corporation (PDEx).
Tenor or term describes the number of years that the bond is going to mature i.e. 5 years, 7 years, 10 years, etc.
Issue date is the date that the tenor starts to take effect.
Maturity date is the date that the bond is redeemed by paying back the capital and all interests owed. Bringing all these concepts all together, see the table below.
|Security||ASEAN green bond|
|Offer period||January 22, 2020 to January 28, 2020|
|Issue date||February 6, 2020|
|Maturity date||February 6, 2025|
Credit rating is a measure of the credit-worthiness of the issuance. It gives investors an idea on how stable the company with respect to paying interest as scheduled and the capital back upon maturity. It is assessed and given by a credit rating agency. Examples are Standard and Poor’s, Moody’s, and Fitch. Locally, we have the Philippine Rating Services Corporation (PhilRatings).
Most corporate bonds are tradeable. If investors would want to give up their holdings, they can sell them to the secondary market subject to fees and taxes.
Some bonds are calleable, which means that the company reserves the right to buy back the bonds and pay the investors before maturity. It is usually done during times of low interest rate. The company borrows money at lower interest so it can pay back the investors who hold bonds with a higher interest. In this way, the company can lessen the cost of procuring capital.
What are the benefits of investing in corporate bonds?
What exactly are the advantages when someone buys corporate bonds?Less risky. They are generally considered less risky than stocks. In times of market volatility, they can be regarded as safe havens for anyone who are searching to minimize the chances of capital loss that is inherent in equities trading.
- Periodic income. The interest payments can be suitable for people who may need periodic income. Investors such as retirees and those who’d like to receive regular income can take advantage of the predictable, scheduled payment of interests that the company gives.
- Diversify risk. Because they’re less prone to volatility, they can be added to fund portfolios to diversify and spread risks. An example is a balanced fund where half of the assets are invested in equities and the other half in bonds.
- Shorter terms. Depending on availability, investors are usually given a range of short to medium-term options so their capital is not tied up to longer years of maturity.
- Higher yields. One other benefit is that corporate bonds may offer higher growth potential or yields than the debt instruments issued by the Philippine treasury. This means that bondholders are able to reap more investing in them than investing in government treasury bonds.
- Should investors like to get their money back before maturity,
liquidity is achieved through selling the bonds in the secondary market.
- Credit rating provides a way for investors to measure the degree of risks when investing.
The risks in investing in corporate bond
- They are generally considered more risky than government bonds, which are backed up by the taxpayers.
- There is also credit risks where the company is unable to meet its commitment in paying back the interest and/or capital as scheduled due to cash flow issues, bankruptcy, etc.
- Inflation chips away the income that you get from bonds. When the inflation is higher than interest, the value of your net worth diminishes.
- Callable bonds are also risky especially when the company borrows money to pay you back during the time when there is falling interest rate.
How much can you earn from investing in corporate bonds?
So if you invest in corporate bond, how much can you expect get out of it? it’s a question that is not easy to answer because the rates that you get vary depending on how much the company is offering.
In order to estimate potential income, the table below shows interest earned for a capital of a million pesos over a tenor of 10 years. The interests range from 3% to 8%. Amounts also reflect the 20% capital gains tax.
On the last two rows, you’ll see Gain (%) which is the result when you divide the last balance and the starting capital. CAGR (%) stands for compounded annual growth rate, which describes how your money grow if compounded. It’s a useful figure when you want compare with other investments that grow over time such as time deposits, savings account, LTNCD, etc.
How can you start buying corproate bonds?
There are three ways that you can buy corporate bonds in the Philippines: through selling agents when they’re on offer, through brokers/brokerage companies on the secondary market, and indirectly through managed investment funds. And these are the common requirements that would be asked from you.
- Valid ID
- At least 18 years of age
- Settlement bank account where the interest and capital will be deposited
- Minimum amount
Within offer period, subscribe through the selling agents
When a corporate bond is within the offer period, you may want to read more about the details. More often, you can get information through the business pages of major broadsheets and business news channels. You may also want to visit the company’s page, their profile on the Philippine Stock Exchange website, and other online sources. Here are the steps.
- Reach out to the company or any of their authorized selling agents for the details on the process of subscribing.
- Make sure that you prepare the required documents, as well as other files that may be required such as proof of income for employees and business registrations for enterpreneurs.
- Fill out the forms.
- Pay the minimum amount to invest.
- Wait for confirmation.
Through brokers on the secondary market
If you weren’t able to take advantage in purchasing corporate bonds during its offer period, you may opt to acquire them through the secondary market. You would need to open an account through any of the fixed income brokers on Philippine Dealing and Exchange Corporation (PDEx) duly licensed by the Securities and Exchange Commission.
- Drop by any of the PDEx brokers and request for an SEC-registered salesman.
- The salesman will explain and walk you through the process of opening up cash account and settlement accounts, fees and taxes etc.
- Place your order through the trading platform.
- Once the transaction is executed, you’d receive confirmation.
- You may be interested to read this online guide.
The advantage in trading in secondary market is that you subscribe even after the offer period. The downside that you’d have to deal with broker fees, be familiar on how to execute trading, and other such details.
Invest in bond funds
The easiest way to be able to invest in corporate bonds is through bond funds. These funds are a pool of money from the investing public that is then managed by an investment house to purchase both public and private bonds. They can be convenient because you don’t purchase the stocks directly, the fund manager does that on your behalf. And the minimum amount to subscribe may be less than what is required by the first two methods mentioned above.
- Visit any companies offering mutual funds, UITF, PERA, and VUL.
- Prepare requirements.
- Fill out form to open your account.
- Pay the minimum capital to start investing.
- Get your confirmation.
- You may continue adding up to your investment.
The downside in bond funds is that you do not have any control on the specific bonds that the fund manager subscribe on behalf of all investors.