Sunday, 6 December 2015

Do Retail Bond Investors Get the Poorer Deal?

When Frasers Centrepoint (FCL) announced the issue of its 7-year, 3.65% retail bond on 12 May 2015, it was preceded by another announcement just a day earlier regarding the issue of a perpetual securities that carry a coupon rate of 5.00%. In fact, the perpetual securities were not the only bonds issued by FCL since its listing on SGX in Jan 2014. There were 2 other bonds, namely a 4.88% perpetual securities and a 7-year, 3.95% Fixed Rate Notes, both issued in Sep 2014. Thus, among all the bonds issued by FCL within a short span of 8 months, the 7-year, 3.65% retail bond has the lowest coupon rate. All other wholesale (i.e. non-retail) bonds have higher coupon rates. It raises the question whether retail investors have the poorer deal when it comes to new bond offerings.

Shortly after FCL's retail bond issue, Aspial, Perennial and Oxley all issued their own retail bonds with coupons ranging from 4.65% to 5.25%. Like FCL, all 3 companies have issued wholesale bonds before the retail bond offering. Let us study whether it is true that retail investors have the poorer deal when it comes to new bond offerings. 

The figure below shows the Yield-to-Maturity (YTM) of the various bonds issued by the above-mentioned companies that are available on Bondsupermart. Each colour represents all bonds issued by a particular company. The retail bonds are identified by a label next to the points. As an example, Aspial have 5 existing bonds, shown in purple in the figure. Its retail bond has the highest YTM and longest maturity among all its bonds. Also shown in the figure are the 3 lines representing the YTM of the risk-free Singapore Government Securities (SGS), high investment-grade bonds rated A3 by Moody's and the lowest investment-grade bonds rated Baa3 by Moody's. These lines provide a reference to determine whether the bonds are fairly priced or not. Please see Benchmarks for Retail Bond Pricing for more details on how to price a bond.

Fig. 1: Wholesale Bonds versus Retail Bonds

At first glance from Figure 1, the retail bonds appear to be priced fairly in line with their wholesale cousins after accounting for unique bond features that could introduce a premium or discount to the YTM, such as putable features (which results in lower YTM) and callable or step-up coupon features (which results in higher YTM). However, on closer look, there are differences in the yield spread between wholesale bonds and retail bonds. In bond pricing, every 0.01% in yield counts. 0.01% is so important that it has a special name – a basis point. If you compute the YTM spread between the bonds and Baa3-rated bonds, retail bonds have lower spreads compared to their wholesale cousins ranging from 0.11% to 0.30%. What it means is that retail bonds are actually more expensive.

The correctness of the above analysis is dependent on 2 assumptions, namely, (1) the spread is constant across all bond maturities and (2) the reference yields are correctly constructed. In view of these limitations, let us consider perpetual bonds which do not have such limitations. There are 3 perpetual bonds listed on SGX, namely, DBS 4.7%, Genting 5.125% and Hyflux 6%. Like the other companies mentioned above, they also have wholesale perpetual bonds. Let us look at each of them.

Fig. 2: DBS' Perpetual Bonds

Figure 2 shows the perpetual bonds issued by DBS. The first bond (DBSSP 4.700% Perpetual Pref) is a retail bond. As can be seen from the figure, it has the lowest YTM among all the bonds.

Fig. 3: Genting's Perpetual Bonds

Figure 3 shows the perpetual bonds issued by Genting. Both bonds have the same coupon, but the first one is the retail version. Again, it has a lower YTM compared to its wholesale cousin.

Fig. 4: Hyflux's Perpetual Bonds

Figure 4 shows the perpetual bonds issued by Hyflux. The first bond (HYFSP 6.000% Perpetual Pref) is the retail bond. Similarly, it has the lowest YTM among all the bonds.

Thus, it is fairly conclusive that retail bonds are priced more expensively compared to their wholesale cousins. This is to be expected, since wholesale bonds are traded in multiples of $250,000 and hence not accessible to most retail investors. Nevertheless, retail investors should be vigilant and not let ourselves be taken advantage of.

P.S. I am vested in FCL's 3.65% bond and CapitaMallsAsia's 3.8% bond.


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