Cover Story: Retail bonds time for a reset

This article first appeared in Wealth, The Edge Malaysia Weekly, on June 28, 2021 - July 04, 2021.
Cover Story: Retail bonds time for a reset
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The local retail bond market, which kicked off more than eight years ago, has yet to gain the kind of traction seen in Singapore and Thailand. The consensus view is that a lot more needs to be done for this market to really get going. 

Moving forward, a boost could come from technology and the growing demand for other investment options apart from equities.

More than three years ago, the Securities Commission Malaysia (SC) introduced the Guidelines on Seasoned Corporate Bonds and Sukuk. By lowering the threshold of bond investments to RM1,000, the regulator removed a significant barrier that had prevented most retail investors from participating directly in the local bond market.

For many years, the man in the street could only access the bond market through unit trust funds. A fund house would collect money from numerous investors to buy bonds on the primary market for future returns. A government bond issued on the primary market is usually purchased at RM10 million per lot, while a corporate bond is typically RM5 million. 

Sophisticated investors with an annual income of at least RM300,000 have another option. They can go to a bank that offers private banking services, and the bank will “slice” a single bond lot into smaller, or odd, lots of RM250,000 each for them. This is commonly known as purchasing bonds over the counter (OTC).

This amount for an odd lot is still a considerable sum for many. That explains why the local bond market is dominated by institutional investors such as insurance companies, corporates and fund houses. 

“The Malaysian bond market has always been touted as a success story. But we underperform some of our neighbouring countries such as Thailand when it comes to the retail bond market,” says Chris Lee, group CEO of RAM Holdings Bhd. 

Indeed, retail participation in the local bond market has gained little traction in recent years after the introduction of the Guidelines in April 2018. Since then, iFast Capital Sdn Bhd — operator of the online unit trust fund distribution platform FSMOne — has been the only eligible distributor of seasoned bonds that investors can access at RM1,000. 

According to Wong Weiyi, general manager of iFast, about 400 investors have traded seasoned bonds on its platform over the past two years. The total turnover of its seasoned bond business is RM10 million, which is a relatively small sum. 

It is unfortunate that retail investors do not explore seasoned bonds listed on the market. There are 17 government, corporate and perpetual bonds listed on FSMOne’s Bond Express platform, with coupon rates of 4.18% to 5.95% and tenures ranging from 3 to 20 years (excluding perpetual bonds, which have no maturity date). A simple comparison with the current fixed deposit rate of 1.75% makes these bonds rather attractive.

“There has been no default on the seasoned bonds offered through our platform,” says Wong. 

Recently, a perpetual bond issued by CIMB Group Holdings Bhd in May 2016, with an annual coupon rate of 5.8%, was redeemed on May 25. Assuming an investor bought the bond a year later in May 2017 and held it for the next four years with the yield unchanged at 5.8%, they would have enjoyed an annualised return of about 4.6% (excluding fees) and got back their principal. 

The likelihood of a default on seasoned bonds is relatively low as the Guidelines are quite stringent. For instance, the bonds have to be issued for more than 12 months in the market. They need to have a minimum rating of A, or its equivalent, given by a credit rating agency registered with the SC. They must be plain vanilla bonds, not structured products or asset-backed securities, guaranteed by a listed company or government-linked company, among others, says Wong. 

Those who invest directly in bonds would have a greater sense of certainty compared with investing via unit trust funds, he adds. “If your bond yield is 5%, you will get that rate of income every six months until the bond matures. If you plan it well, you will get a steady cash flow into your bank account, which is good for retirees to plan their finances. 

“If you invest in bond funds, you are unsure what kind of returns you will get. You will receive income when the fund house announces an income distribution. When you need cash, you will need to sell some units. 

“I am not saying that one is better than the other. Rather, if you understand the characteristics of both products, you can decide which is more suitable for you.”

Why retail bonds are not hot

Daniel Brown, head of fixed income at CGS-CIMB Securities Sdn Bhd, points out that Bursa Malaysia embarked on an initiative to promote retail participation in 2013. It introduced the Exchange Traded Bonds & Sukuk (ETBS) platform that allows investors to buy into bonds at about RM1,000 (depending on the price of the bonds), like buying shares. 

The first bond listed on the platform was by Danainfra Nasional Bhd in January 2013, with a coupon rate of 4% and tenure of 10 years. Fast forward to 2021, three bonds are listed on the platform, with Danainfra being the sole issuer. Trading activities are scant.

Brown says the lacklustre response is due to structural challenges. The local bond market has been operating smoothly with single-bond issuances of above RM1 billion on the primary market with standard lot sizes of RM10 million and RM5 million for government and corporate bonds respectively. This has not changed for many years and has served key industry stakeholders well. 

Bond issuers, which are the government and corporates, have successfully raised funds from institutional investors with such lot sizes, reflected in the bid-to-cover ratio, which serves as an indicator of market demand for a particular bond during an auction. 

“The ratio ranges between two and three times in general. It means when a government or corporate offers, let’s say, RM1 billion of a 10-year bond in an auction, the bids it receives could go up to RM2 billion or RM3 billion. As market demand outstrips supply, issuers have little incentive to auction bonds in smaller lot sizes,” says Brown. 

Institutional investors with deep pockets should see little reason to reduce lot sizes too. Take an insurance company. With billions of ringgit at its disposal, it can deploy that money more efficiently in the bond market with RM10 million per lot or more than that in smaller lot sizes of, perhaps, RM250,000. 

A reduction in lot size would mean institutional investors have to submit more bids during an auction to buy up the desired amount of a particular bond. The success rate of them getting the targeted amount of the bond could also be lower. 

“Assuming the lot size is smaller with more participants in an auction, the allocation of the bonds could be more spread out. And each bidder is likely to get a smaller amount of a bond,” says Brown. 

A bigger lot size is more cost-effective to the investment banks that help the government and corporates raise funds through bond issuances. By targeting institutional investors, instead of the retail market, the amount of time and effort spent by banks on paperwork and other due processes is significantly reduced, which translates into higher profit margins. 

Profits matter, after all. Wong says the profit margin of iFast’s seasoned bond business is very thin. “If you were to run a business like this on its own, you would find it very hard to sustain.”

The Bond Express platform was possible because iFast derives the bulk of its income from the distribution of other financial products, including unit trust funds, insurance policies and stockbroking services most recently. The company can also cross-sell seasoned bonds to its existing clients to generate income. 

There are very few bonds offered to retail investors as the focus has always been on institutional investors, industry players observe. As at June 1, there were 20 bond issuances that investors could access at about RM1,000 — the 17 listed on FSMOne’s Bond Express and three on Bursa’s ETBS platform. 

The lack of liquidity also plays a part in the slow take-up among retail investors. “Institutional investors usually don’t sell their bonds and tend to hold them to maturity. That is why we have liquidity providers such as iFast and investment banks [in the case of ETBS] that help facilitate trades on the secondary market by slicing up bonds into smaller sizes,” says Wong.

“However, liquidity providers would not be doing it for long if it were a business that loses money. Some liquidity providers for the ETBS have quit the business.”

Education is another factor that contributes to the low participation rate. An industry player points out that retail investors are used to trading stocks with higher volatility, risks and returns, without realising the benefits of holding a bond to maturity that would provide them with attractive and stable income. Many retail investors also do not understand how bond prices move and the strategies that they can apply.

Additionally, many investors may not be aware that investing in bonds via banks incurs a fee, which has to be taken into account when calculating real returns.

More to be done

RAM’s Lee says more can be done to spur interest in the bond market among retail investors. He draws insights from two sources: The Investment Account Platform (IAP) and peer-to-peer (P2P) financing industry. 

The IAP was an initiative by Islamic banks and Bank Negara Malaysia in 2016 to provide investors with a wider shariah-compliant investment option. RAM is the sole credit rating agency of the initiative, offering independent credit opinions on businesses that want to raise funds via the platform. 

The initiative allows high-net-worth individuals to open an investment account with an Islamic bank that is an IAP participant. They can then invest as low as RM5,000 (depending on each bank) in Islamic loans with yields ranging from 5% to 8%. 

These loans are rated A3 and below by RAM. They come with an issue size of RM20 million to RM30 million, much smaller than that of bonds issued on the primary market, at RM1 billion and above, says Lee. “High-net-worth investors have no problem subscribing to these loans on the IAP,” he adds. 

The P2P financing industry, where licensed platform operators pool funds from the public and use them to finance small and medium enterprises (SMEs), has been growing fast over the past three years. These operators let retail investors invest in SMEs for as little as RM50. 

According to data provided by the SC, the P2P financing industry raised RM213.76 million in 2018. In 2019, the amount increased 195% to RM632.38 million. Last year, it was RM1.14 billion, a growth of another 80%. 

Statistics provided by the SC does not show the breakdown of funds raised through institutional investors and individual investors. But it does show that 92% of those on P2P financing platforms last year were retail investors, 7% sophisticated investors and 1% institutional investors.

The growth of the IAP and P2P financing industry implies that there is demand from individual investors for fixed-income instruments. But they need to be offered the right products. 

In addition to smaller lot sizes, retail investors are more receptive to bonds with higher yields and relatively lower credit ratings. However, the average interest rate of about 12% offered by P2P financing platforms could be too high for many people, especially retirees, given the risk associated with it. A yield of about 5%, compared with the current fixed deposit rate of less than 2%, should be just nice for them. 

The tenure of these bonds should range from one to five years. “Beyond five years and you are really stepping into the sophisticated investor market; no longer the retail market,” says Lee. 

Liquidity, which many say is a hindrance to retail participation in the bond market, could be less important when investors have access to bonds with shorter tenures, he adds. “Liquidity is a concept that can sometimes be overkill. If I am investing in a 10- to 20-year bond with a large amount, I may want to exit at any time. But once I play the short end of the market (which means investing in bonds with shorter tenures), liquidity becomes less important.”

Lee says several smaller public-listed companies have shown interest in issuing bonds with a coupon rate of about 5%. But the issue size needs to be reduced to RM40 million to RM50 million from RM1 billion currently. 

“Let’s say a company needs financing of RM80 million to RM100 million with a mix of fixed-rate and floating-rate loans. It can raise half of the total loan amount at a fixed rate from the bond market. It would be happy to do so if possible,” he says. 

To make this happen, industry players need to sit down together to standardise the various documentations and processes, so that these bonds in smaller sizes can be issued at a lower cost. And technology will play a crucial role in lowering the issuance cost, says Lee.

Technology as a growth catalyst 

Wong concurs with Lee that technology plays a crucial role in democratising the local bond market. In fact, iFast has relied on its technology to trade bonds with its clients online. 

“Our clients can trade bonds with us 24/7 at their comfort. We enabled this more than a year ago,” he says. 

Technology enhances transparency, which benefits the man in the street. For instance, Bond Express users know the spread they will have to pay to buy or sell bonds on the platform, which is generally 0.5%. They will also fork out a processing fee of 0.5% and a platform fee of 0.18% a year for the bond they buy into.

“We will tell you exactly how much to pay. You can then calculate your net yield after deducting those fees,” says Wong. 

All this may seem like basic information, but it is not accessible to most sophisticated investors who trade bonds via the OTC market with a bank. 

On the OTC market, the bank usually quotes the price of the bond that the individual investors wish to buy or sell. There is no breakdown of the spread and various fees involved in the transaction. It is up to the investors to take the offer or negotiate the price based on their knowledge and information. 

“The price you are quoted could depend on your relationship with the bank. You won’t be able to tell whether there is a huge markup or not,” says Wong. 

Tan Dao Hong, fixed-income dealer and market maker at iFast, says global bond transactions, including those in Malaysia, are predominantly conducted on the OTC market. But the market is increasingly allowing investors to trade bonds online through an exchange, similar to how they trade shares. MarketAxess and Tradeweb are two examples, he adds. 

“These platforms bring market participants together, including institutional and retail investors, and facilitate bond trades between them. They aim to make the market more transparent with better price discovery. This trend is growing quickly in developed countries such as the US,” says Tan. 

Wong says iFast is looking to set up such a platform in Asia, which can help the company save costs. “Investors trade with iFast via the Bond Exchange. It means we buy and keep bonds in the inventory before offering them to investors in smaller sizes. Keeping these bonds on our books comes at a cost. An exchange that facilitates trades between investors means that we wouldn’t need to keep all those bonds in our inventory.” 

Technology is already changing the bond market locally, albeit in a smaller way, says Wong. For instance, the Bond and Sukuk Information Exchange (BIX), a non-profit information platform, provides market information to the public for free. 

This information includes news announcements, upcoming bond issuances and the top 10 daily transactions in the bond market. Research reports released by research firms and credit rating agencies are also available. 

 

The role of the SC

The Securities Commission Malaysia (SC) acknowledges that the growth in the local retail bond market has been gradual due to supply and distribution channel constraints. 

The regulator says the typical investment size on the Exchange Traded Bond & Sukuk (ETBS) platform is between RM7,000 and RM10,000 per individual, whereas for seasoned (or retail) bonds and sukuk, it ranges from RM4,000 to RM30,000.

“We have been encouraging prospective distributors, advisers and issuers to explore this market segment. Nevertheless, the decision to issue or distribute retail bonds or a retail tranche [of bonds] rests on the individual corporate issuer and distributors,” it says.

The SC is exploring the need to increase distribution channels of retail bonds and sukuk as well as other measures that can encourage greater market participation of investors and issuers. The regulator is also looking at facilitating new participation in the retail bond and sukuk market and supporting technology-based initiatives that promote wider access to the market. 

“We see the use of technology as essential in improving fundraising efficiencies and facilitating access to diverse and quality assets which, in turn, will enhance liquidity,” says the SC. 

Investor awareness and education are key to a more robust retail bond and sukuk market. The SC will be increasing its efforts in this area by collaborating with the Securities Industry Development Corporation (SIDC) to develop specific programmes and events on retail bonds and sukuk for investors. 

It is essential that retail investors have direct access to the bond and sukuk market as it provides them with greater investment options across various asset classes, says the SC. “We will continue to engage with industry players to identify measures to spur the growth of the market. And we will provide the necessary support through our involvement in industry-led events.”

 

How do fees play a part in your bond investment?

BUYING ON IFAST  

If a retail investor buys bonds on FSMOne’s Bond Express, there is a processing fee of 0.50% of the bond price (or a minimum of RM35) and a platform fee of 0.045% per quarter (which translates into 0.18% per annum). The latter includes custodian fees and other value-added services such as research reports and tools. 

To put it simply, an investor who pays RM10,000 at nominal value for a bond incurs a RM50 processing fee and RM4.50 platform fee (depending on the average daily price of the bond in a given period), which totals RM54.50.

Assuming the same investor bought a corporate bond issued by a bank that had a coupon rate of 5.45% and 10-year tenure, he would receive RM545 each year and a total of RM5,450 over 10 years. The net return would be RM5,220 after deducting RM54.50 (processing fee of RM50 plus first quarter platform fee of RM4.50) and RM175.50 (platform fee for the remaining three quarters of the first year plus four quarters in each of the following years). The annualised and total return over 10 years would be 4.29% and 52.2% respectively.

There is also the bid-ask spread. This is the difference between the highest price that a buyer is willing to pay for the bond and the lowest price a seller is willing to accept. The spread is another cost that investors would need to bear if they were to sell their bonds before maturity to iFast Capital Malaysia through the Bond Express platform. 

A quick check online shows that the spread is about 0.5%. However, the eventual rate will depend on the company’s financial and market conditions. 

BUYING THROUGH A PRIVATE BANK

In the case of most local banks, the fees involved in such transactions are included in the mark-up price of the bond they offer to clients. 

“It is similar to buying foreign currency from a money changer. They offer you a price rate [which includes the profit they make]. You then decide whether to exchange your ringgit for another currency with them,” says a banker who does not want to be identified. 

In general, the mark-up rate, or spread, ranges from 0.5% to 2%. The rate ultimately depends on each bank. It also depends on the size of the transaction — whether it is RM250,000 or RM500,000 — and the investor’s relationship with the bank. 

“The custodian fee is tiny to banks. It is a fixed cost that banks charge their clients each year, or they can waive it,” says another industry player. 

Assuming an investor bought a corporate bond with a 5.45% coupon rate and 10-year tenure from the bank (like in the example above). If the custodian fee is waived, the investor would pay RM1,250 (0.5%) to RM5,000 (2%) upon purchasing the bond. 

After deducting the spread, he would receive RM131,250 to RM135,000 after 10 years. The annual and total return over a decade would range from 4.31% to 4.41%, and 52.5% to 54% respectively.