Questions to ask
before buying bonds
Three questions to ask before buying bonds
Given the volatile global economy and rising corporate defaults, investors must be armed with the right information before taking
the plunge. Koh Hwee Joo, Head of Asia Fixed Income at UOB Asset Management (UOBAM), shares what you need to know before
investing in bonds.
1
What is the market outlook?
Before making any investments, investors should first understand
the global macroeconomic and investment market conditions.
With a good understanding of the “why and how”, you may
better identify potential risks.
Asia has gone through a credit boom, especially in commodityrelated sectors, given low interest rates. Robust commodity
prices and market anticipation of a further rally resulted in many
companies taking bigger loans and raising funds to increase
capacity. China’s growth story also led to an increase in credit to
raise funds for new business ventures.
2
However, the market optimism has been short-lived. The
economy is currently going through a slowdown with weak oil
prices, increased uncertainty and higher market volatility. It is
even more important for investors to understand and identify
the underlying investment risks in bonds as an asset class.
In addition, there is also a common misconception that bonds
are a defensive asset class with their performance wholly
dependent on interest rate trends – this is not entirely true.
Investors also need to be mindful of other broad risks such as
credit risk and diversification risk.
How should investors select bonds for their portfolio?
Credibility of the bond issuer
“... we believe that intrinsic value may
only be uncovered through detailed
credit analysis and our professionals’ vast
investment experience.”
First, investors must differentiate between the various types of
bonds issued by governments, government-related organisations
and corporations. Bond investors should also understand the
ratings of the bonds issued.
You may refer to bond ratings by international rating agencies
such as Moody’s, Standard & Poor’s and Fitch (table below) as a
guide for credit quality assessment.
At UOBAM, we do not wholly rely on international rating
agencies. Instead, we believe that intrinsic value may only be
uncovered through detailed credit analysis and our professionals’
vast investment experience.
Second, different issuers have different risk profiles. For
example, bonds from issuers with poor credit fundamentals will
be classified as risky bonds.
Third, bond issuances may have varying structures. In the event
of debt distress, some bond structures may see subordination
of bondholders, leading to difficulties in debt recovery.
Investors need to have a deep understanding of both the bond’s
underlying fundamental profile and issue structure before
investing in bonds.
Moody’s
S&P
Fitch
Meaning
Moody’s
S&P
Fitch
Aaa
AAA
AAA
Prime
Aa1
AA+
AA+
Ba1
BB+
BB+
Ba2
BB
BB
Aa2
AA
AA
Ba3
BB-
BB-
Aa3
AA-
AA-
B1
B+
B+
A1
A+
A+
B2
B
B
A2
A
A
B3
B-
B-
A3
A-
A-
Caa1
CCC+
CCC+
Substantial Risks
Baa1
BBB+
BBB+
Caa2
CCC
CCC
Extremely Speculative
Baa2
BBB
BBB
Caa3
CCC-
CCC-
Baa3
BBB-
BBB-
Ca
CC
CC+
In Default with Little
Prospect for Recovery
High Grade
Upper Medium Grade
Lower Medium Grade
Junk
Investment Grade
Higher Risk, Higher Potential Return
Meaning
Non Investment
Grade Speculative
Highly Speculative
Source: uob Asset Management, as at end March 2016
Diversification
Liquidity
It is crucial to diversify within your bond portfolio, especially
when there is rising risk to the individual corporate, also known
as idiosyncratic risks. With slowing global growth and a high
level of corporate leverage, investors need to scrutinise the
credit profile of every single corporate as default rates may pick
up. In addition, better diversification of the bond holdings will
help to minimise big swings in the overall market valuation of
the portfolio.
Investors should also consider the liquidity of the market
and individual bonds when investing. Before the 2008 global
financial crisis (GFC), global bank bond traders typically dealt
in large quantities. However, with lessons learnt from the GFC,
global bank regulations are now tighter and it is more restrictive
and costly for traders to hold bonds.
“With slowing global growth and a high level
of corporate leverage, investors need to
scrutinise the credit profile of every single
corporate as default rates may pick up.”
3
Bond traders are, therefore, exercising more caution. These
factors have led to a reduction of trading volume and market
liquidity. This, in turn, widens the trading bid-ask spread and
reduces the pool of frequently-traded liquid bond issues.
As a result, end-investors may increasingly encounter lowerthan-market prices should they need to sell off their bond
holdings urgently to raise cash.
What are the risks of high-yield bonds?
High-yield bonds are typically bonds which are rated below
investment grade by international rating agencies, and are
suitable for investors with higher risk appetites. Issuers of these
bonds typically have weaker underlying fundamentals. However,
a bond issued by a blue-chip, established organisation may also
be a high-yield bond if it has a weak issue structure.
Credit risk is usually much higher for high-yield bonds when
compared with investment grade bonds due to the issuers’
often-smaller balance sheets and scale of operations, which also
constrain the size of issuance. This, coupled with the current
reduced risk appetite of banks for high-yield bonds, may result
in lower market liquidity.
Investors will also need to know the legal framework of bonds.
Understanding the legal framework not only helps in the debt
recovery process in the event of a default, but investors would
also be able to better assess the true underlying value of the
issuer in times of distress.
Having a close relationship with bond issuers would enable
investors to better understand their business strategies even
if there are concerns in the market. Investors would be more
informed of their investment risks and if they are adequately
compensated in return.
With much more emphasis on the qualitative aspect when it
comes to assessment of a high-yield bond, the experience of
the investment manager will be one of the main differentiating
factors for bond performance. This is also why a high-yield bond
portfolio is always assessed and managed by a more experienced
investment manager.
“With much more emphasis on the
qualitative aspect when it comes to
assessment of a high-yield bond, the
experience of the investment manager
will be one of the main differentiating
factors for bond performance.”
Hwee Joo joined UOBAM in August 2015.
She has more than 16 years of fixed income
investment experience, specialising in Asian
fixed income markets.
Prior to joining UOBAM, Hwee Joo was
with Amundi Asset Management as a
Senior Portfolio Manager. She was also the
Asian credit portfolio manager responsible
of managing all the Asian credit exposures
within the firm.
Ms Koh Hwee Joo
Head of Asia Fixed Income,
UOBAM
Prior to Amundi Asset Management,
she worked at Tokio Marine Asset
Management (TMAM), APS Komaba (APSK)
Asset Management and Nikko Asset
Management in Singapore. At TMAM, she
led and managed their first Asian bonds
mandate. Before that, she spent five years
with APSK Asset Management, managing
both Asian local and hard currency bond
relative mandates for regional Central
Banks, pension funds and corporations.
She started her investment career at Nikko
Asset Management where she managed
currency overlay mandates and various
SGD local currency bond mandates,
playing a critical role in the Fixed Income
team which received many awards for its
retail funds.
Hwee Joo graduated with a Bachelor of
Business in Accountancy (with Merit) from
Royal Melbourne Institute of Technology
University in 2000.
Important Notice & Disclaimers
This document shall not be copied, or relied upon by any person for whatever purpose. This
document herein is given on a general basis without obligation and is strictly for information
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You may wish to seek advice from a professional or an independent financial adviser about the
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UOB Asset Management Ltd
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June 2016