More tapping retail bond market

LATE last year, as Japan’s equity market was being hammered as its economy was feeling the heat from the US financial crisis, there remained one safe haven – its retail corporate bond market. Viewed as safer than stocks given that it provided relatively steadier returns and was not vulnerable to the wild swings of foreign exchange, retail investors were flocking to invest their monies in the bond market.

In turn, many blue-chip companies for the first time started to tap the retail bond market to raise funds as over at the primary bond market, institutional investors were gripped by severe risk aversion, having been burnt elsewhere. In fact, in December alone, seven companies issued retail corporate bonds (rated investment grades with little risk of default) totalling nearly 600 billion yen (about RM166.8bil), 27 times the amount a year ago!

Back home, while there has long been talk of widening the pool of investors in the bond market, currently dominated by institutional investors and high net worth individuals, to the man-in-the-street, there still appears much to do with regards to this end. As it stands, retail investors’ only exposure to the bond market is via bond funds managed by unit trust companies.

But even as the benefits of retail participation in the bond market may be aplenty, there are still mixed views on whether promoting retail participation in the country’s bond market is the best way to go.

Uncertainty in the global economic climate has led investors to play safe, confining themselves to “safe havens” such as government bonds and highly-rated private debt securities (PDS) as well as sukuk.

Concerns arise that investors’ interest in double-A rated papers in the private debt security (PDS) market has waned considerably, indeed a significant setback in the long-term development of the domestic bond market.

According to Bond Pricing Agency Malaysia Sdn Bhd (BPA) chief executive officer Meor Amri Meor Ayob, opening up the bond market to retail investors will help boost the PDS market, in particular for the double-A and single-A rated papers, which offers much higher yields compared to fixed deposit rates.

“However, it is important that only the higher quality papers, which have less risk of defaults, are offered to the public,” Meor Amri asserts.

Meor Amri notes that overwhelming response to the initial amount of RM2.5bil Sukuk Simpanan Rakyat by Bank Negara, which was fully subscribed within two days, shows that there are a lot of pent-up demand among retail investors for higher yielding investment products.

He also points out that one of the biggest investors in the bond market is the Employees Provident Fund (EPF).

“If the EPF is investing using the public’s retirement savings, why can’t the public be allowed to invest directly in the domestic bond market?” Meor Amri argues.

Meor Amri says that while retail participation in trading of bonds is possible in markets such as the United States, Malaysian retail investors are less exposed to the mechanics of the bond market compared to the more established equity market and as such, market education is important.

Educating the masses

Having said that, he concurs that this is the most opportune time for retail investors to participate and take advantage of the high yields and widening credit spreads in the bond market due to risk aversion.

One way to boost retail participation is by coming up with retail bond issues that will be traded on a different platform from those that are open to institutional and high net worth investors.

This is largely because presently, trading of government and corporate bonds are done over the counter at inter-bank level with a minimum trade amount of RM5mil.

As it would not be cost effective to issue retail bonds in the same way as larger denominated ones, a better alternative would be to allow commercial banks to distribute smaller denominated bond issues to retail investors.

Another way is to list the bonds and sukuk in the local stock exchange to enable retailers to scoop them up. A check with the Securities Commision reveals that a new framework was introduced in December to facilitate the listing of bonds in Bursa Malaysia to widen the investor base but it is still limited to institutional investors such as insurance companies, which have restrictions when investing in unlisted securities.

Meanwhile, Bursa says it is looking at the feasibility of having exchange traded bonds issued by existing public listed companies, private companies as well as financial institutions to be listed and traded on the exchange and be accessible to retail investors.

RHB Investment Bank Bhd managing director Chay Wai Leong concurs that it is possible to allow retail participation as the ringgit bond market is very dynamic and the second largest in terms of total market outstanding relative to gross domestic product in Asia.

The challenge is in setting up the trading platform but Chay opines that the issue of higher transaction costs arising from opening up the issue to retailers can be easily ironed out and should not stand in the way as the benefits of wooing retail participation are aplenty.

Can it be complicated?

In the past, there was no compulsion to look into issuing debt papers to retailers as long as there was adequate demand from institutional investors.

But it would be a natural progression in the domestic capital market, particularly now, as interest rates are low and retail investors are looking for higher yielding products.

Bond funds is a good way to participate in the bond market as it provides diversification but some retail investors may not want to rely on fund managers to manage their investment and may prefer to invest on their own in the bond market given the choice.

Kenanga Investment Bank Bhd head of fixed income Terry Tan says retail participation should be targeted towards high net worth individuals with good market knowledge of the structure and credit of the PDS.

“These sophisticated investors can assess all the risk associated to investment in bonds and are able to stomach the level of risk involved,” Tan says.

Malaysia Rating Corp Bhd (MARC) chief executive officer Mohd Razlan Mohamed concurs with Tan that it is not necessary to ask regulators to open up the bond market for the man in the street as the technicalities are not easily understood.

Retail investors are attracted to bond funds due to its features such as portfolio diversification, daily liquidity as well as a regular income stream. In addition, bond funds generally are less volatile than equity funds and provide more stable income stream from bond coupon interest payments.

In terms of tax benefits, the interest payments earned from bonds are usually tax exempt, thus providing higher returns.

Bond funds also provide liquidity, allowing investors to buy or sell their units each day.

An investor who prefers to remain anonymous says she purchased the bond fund to provide defensive play to her overall portfolio investment in unit trusts.“It is a safer option compared to equity funds and has provided me with average returns of about 4% over the past three years, which is better than the fixed deposit rates now,” she says.

In contrast, MyFP Services Sdn Bhd financial planner and managing director Robert Foo says his clients have been concerned about credit defaults in bond papers in view of the financial crisis hitting the world and Malaysia and have placed their monies in alternative asset classes to diversify the risk.

“Some clients are also a bit concerned about the government’s imposition of a 30% windfall tax on independent power producers (IPPs) because a substantial portion of the bond papers in the Malaysian market relates to IPP funding,” Foo says.

There are also complaints that some bond funds charge upfront sales fee when there is little reason to do so as bond funds only deliver returns in the lower single digits. “Furthermore, these bond funds are supposed to be held to maturity and not traded like a stock so there’s little active management to charge this upfront fee,” Foo notes.

Local bond funds charge 0% to 1% in upfront fees and 0.5% to 1% in annual fees.

He also points out that there is some dissatisfaction among interested investors on why they cannot use their EPF contribution to invest in certain Malaysian bond funds which invest in offshore fixed income instruments.

Generally, fund managers expect bond funds to perform well in terms of providing competitive returns above safe assets such as fixed deposits despite the current market volatility.

RHB Investment Management Sdn Bhd managing director Sharifatul Hanizah Said Ali says bond funds could benefit from capital gains when there is prolonged low interest environment and potential early redemption premium from bonds as a result of refinancing exercise to take advantage of the low interest rate regime.

“We can expect demand for bond funds to grow, especially when there is renewed confidence in the market and with that, risk appetites of investors,” she notes.

This could come from investors with lower risk appetite following the recent collapse of other higher-risk asset classes in the likes of equity fund, she says.

“They may re-enter the market in a less aggressive manner through bond funds to minimise downside risks,” she says.

Sharifatul Hanizah observes that recent trends show investors are still looking for capital protected funds, hence interest in bond funds are comparatively low.

“Based on the size of bond funds launched in 2008 to date, demand is seen to be relatively low as the biggest fund size is about RM66.7mil only (see table),” she says.

Meanwhile, MAAKL Mutual Bhd chief executive officer Wong Boon Choy says the response for bond funds largely hinges on market conditions. “In times of uncertainties in the stock market and generally when interest rate trends downwards, bond funds appeal to investors who are risk adverse,” Wong notes.

Areca Capital Sdn Bhd chief executive officer Danny Wong is also optimistic about the fixed income market, adding that past average returns for bond funds had been between 3% and 6% over the long term.

However, Wong advises investors to be more thorough in choosing funds as each fund may be different in the underlying investment, duration and risk profile.

“In this weak economy, one should choose a bond fund that is investing in high quality bonds (to avoid credit default risk) with diversified portfolio maturity (liquidity risk or duration mismatching risk) and limited exposure to other volatile factors such as foreign exchange risk (for offshore bonds),” he says.

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