Shiva Sachaphimukh from Farnam Tree gives his insight.
Corporate bond defaults in Thailand have gained significant attention in the news recently. This has spooked many investors who fear a loss of capital when investing in these assets. The appeal of investing in bonds for investors is that they can receive income via interest payments without taking undue risk. When defaults emerge, it can erode confidence.
Reasons are varied for why companies default. In one case, there was an accounting scandal and misdeeds on behalf of those at the top. Other defaults occurred because of weak balance sheets and deteriorating business fundamentals.
Whilst there is reason for concern, we do not think that investors are best served shunning these investments altogether. The sum of bond defaults in the first half of this year accounted for 0.3 percent of total corporate bonds outstanding.
We maintain that bonds have a place in a well-diversified investment portfolio. There are several considerations to consider when allocating capital to these assets to ensure that you are making well-informed decisions.
Make Sure That a Bond is What You Need
Investors need to make sure that adding bonds into their portfolio serves a purpose. Bonds are an excellent investment for conservative investors looking for principal protection alongside the ability to receive income. The better the credit quality – i.e. the safer the company – the lower the coupon, which is the interest rate you as a holder will receive. The opposite is also true with riskier companies paying higher interest.
In general, the longer the duration of the bond, the more you will get paid. The most significant mistake an investor can make is to invest in questionable bonds solely in pursuit of higher returns. Taking such a risk does not always pay off. In these cases, investors may be better off seeking higher returns in equities over purchasing such bond issues.
Diligence Pays Off
Doing some homework can pay huge dividends before making any investment, and that extends to corporate bonds. Relying on the recommendation of someone getting paid to sell you something is not foolproof. Even if you do not know how to read financial statements, there are some things that you can look out for.
Look at high-level financial items such as sales, operating, and net profit. Have there been huge swings in these items, or are they stable? Erratic movements in financial figures are a cause to investigate further.
There is also qualitative analysis that anyone can do. Doing some reading about the company’s business activities and latest developments. This can help in making more informed decisions. If doing the work is too difficult, finding a third party you can trust may help. Independent advice can prove very valuable.
Do Not Only Rely on Ratings
Many investors look at the rating of a bond and take that as a stamp of whether it is a worthwhile investment or not. Credit ratings are meant to be a guide as to the quality of the company in question. The higher the rating, the lower the chances of default – in theory.
The issue with relying solely on such indicators lies in the limitations of rating agencies themselves. These agencies have constraints like a limited scope, delayed updates, potential subjectivity, and the risk of investor overreliance.
Keeping these few points in mind will help you make better decisions when it comes to purchasing bonds for your portfolio.
Farnam Tree is a boutique investment and wealth management firm based in Bangkok. The company is a licensed Investment Advisor under the Thai SEC and Ministry of Finance.