With rising interest rates, we can begin to relook at the idea of purchasing retail bonds for our portfolio. This article considers two retail bond choices for intermediate investors who already have a dividend-yielding portfolio consisting of local blue-chip stocks, REITs and business trusts such as the ones built by the ERM programme.
Constraints for intermediate investors
Intermediate should consider the following constraints when looking at retail fixed-income products.
- The first constraint is that investors already have the CPF programme and can contribute via the CPF Retirement Sum Top Up Plan of up to $8,000 a year into their CPF Special account, giving them a riskless 4% return.
- The second constraint is that, if CPF is not available as an option, a reasonable yield of 3% can be attained with the ABF Singapore Bond Index Fund (Ticker : A35) which invests in bonds backed by the Singapore government.
- The third constraint is that we’re entering a high inflation regime with rates as high as 5%, which makes buying a 4% bond and risking a bond default unnecessary. This is compounded by the US Fed, which is highly likely to raise rates to fight inflation until the end of 2022.
If we apply these constraints, we will be left with fixed income ideas that has to provide at least 5% yield to maturity but we can accept a lower credit rating. And in doing so, we only have two retail bonds to consider.
We can add these fixed-income investments to a portfolio that provides 5—6% dividend yields from banks, real estate, and business trusts and benefit from diversification when we do so.
2 novel fixed income choices in an era of rising interest rates
a) Astrea 7 Class B bonds (Ticker: V7BB)
At the time of writing, Astrea 7 Class B bonds, denominated in USD, are currently available for application at the nearest ATM or online banking facilities. Successful purchasers will get a bond that pays 6% in two 3% coupons, denominated in USD, every year for at least the next six years. If the bonds are not redeemed in year 6 or 2028, the coupon will be raised to 7%.
The bond currently has a Fitch rating of BBB+, which is investment grade but cannot be benchmarked against the Astrea series Class A bonds, which have a much higher credit rating. Fortunately, on the FSMOne website, we can get data on a similar Class B bond from the Astrea 6 series, which has a Yield to Worst return of 5.79%, making it fair to predict the price after listing on SGX would head above $1.
b) SIA Mandatory Convertible Bonds (Ticker: WPOB / YQ7B)
Another intriguing candidate for the intermediate investor is Mandatory Convertible Bonds issued by SIA. SIA was facing dropping sales during the pandemic and had to raise funds in 2020 and 2021. The result was an interesting fixed-income product that did not pay a coupon, and gave SIA the freedom to decide when they could call back these bonds.
Mandatory convertible bonds by SIA can be called twice a year. For every time period that SIA does not redeem these bonds, investors get 4% returns for the first four years of the MCB’s existence. Then it steps up to 5% for three years before stepping up to 6% for the remaining tenure.
The following table shows how much you stand to gain when the bond gets called at a particular date.
For example, at the time of writing, 2021 MCBs (Ticker: YQ7B) are trading at $95.5. If you own this MCB and SIA decides to redeem the bond in June 2025, just before the interest ramps up to 5%, you will get back $117.166. Buying the 2021 MCB now would have been the equivalent of earning 6.94% p.a. over the holding period of three years.
If, by June 2030, the bonds have yet to be redeemed, they would convert to 350 shares of SIA, which is about $4.84.
The disadvantage of investing in MCBs is that you don’t get a coupon or dividend at a regular basis, just a guarantee of how much you will earn when the bonds get redeemed. While there is no guarantee that MCBs will be redeemed soon, SIA does have an incentive to expedite the redemption process as SIA shares are already very high at $5.50. When the aviation business gets better, they can find cheaper forms of financing. Consequently, some experts even predict redemption in 2023.
Time to think about these fixed income ideas
As the US Fed cannot raise interest rates forever since a strong USD will weaken their exports capability, we can expect retail fixed income products to become viable possibly by the year-end. Right now, it is helpful to start thinking about what’s available on an investor’s radar and these two products are a good starting point.
The only disadvantage I see is that local brokerages do not seem to have a scheme to accept these products as security for margin accounts.
Note: The Early Retirement Masterclass currently does not hold any of these products in its student portfolios but one chapter is devoted to retail fixed income instruments.
