Stock investors are shareholders, whereas bond investors are creditors of the bond and creditors get paid before shareholders – which explains why bond investments are less risky when it comes to corporate investments. Regardless of the company’s profitability, a bond investor will still earn a promised return through coupon payments – unlike a shareholder – unless the company issuing the bond defaults.

Michael Chang – Chief Investment Officer, Fixed Income at RHBAM – shares some advice on investing in bonds.

Chang believes that the popularity of bond investments has grown over time and that they are a core component to an investor’s portfolio. That said, the weightage of the bond component depends on age and individual risk appetite: “If you’re in your 20s, you probably have a higher risk appetite and that might mean an 80/20 allocation – 80% being equities and 20% in fixed income.”

“In your 30s, that might change to 60/40,” Chang says. He adds that in your 40s or 50s, it might even be 50/50 or 40/60 (60% in fixed income). “For personal investments – I would recommend a diversified portfolio consisting of government bonds, corporate bonds, equities, and cash to minimise risk and to ride favourably on any asset market cycle,” he advises.

How to earn returns from bonds

Fixed income investments such as bonds offer stable returns and Chang says there are two ways to go about obtaining them. “The first is in the form of accrued interest, which can be higher than what you earn from a fixed deposit or savings account,” he reveals.

Unlike a fixed deposit – where the interest is only paid at maturity – bonds typically carry coupon payments paid semi-annually. Depending on the tenure and rating of the Ringgit bonds that you invest in – for example – coupon payments could range from 4-5% for a three-year corporate bond.

“That 4-5% only applies if you bought the bond at primary and hold it to its maturity,” Chang explains. “Three years of holding bank bonds might give you 4% per annum, so if you generate 4% every year for three years – that’s a total of 12% cumulative returns,” he adds. That 4% for a bond is also on the safer side of an investor’s risk appetite.

Chang reveals that the second way to earn returns from investing in bonds is through capital gains – when you buy and sell bonds. Unlike a fixed deposit, investments in bond at times allow you to trade on it; either for capital gains or liquidity. “This is particularly fruitful when you go in at bond auctions or primary issuances or even when there is a bond sell-off,” he says.

Additionally, with the added advantage of bonds being tradeable, you do not lose the interest by selling prior to its maturity. This is unlike a fixed deposit investment, which penalises you in terms of the interest you are entitled to receive in the event you uplift your fixed deposit prior to its full maturity.

Chang says this form of active management when it comes to investing in bonds makes sense, adding that this can also complement other forms of active trading.

A note of caution when investing in bonds

“In a market that sees a lot of foreign investment in bonds, yields are pushed down,” Chang explains. “There will be years with subtle bearish market conditions, but once you lock in the yield – if there is nothing happening to the credit – you will still earn 5%, which is ultimately better than a fixed deposit rate of 3% in Malaysia,” he discloses.

Chang says sophisticated investors sometimes look into higher-yielding country bonds (high-yield bonds) – which may offer higher returns in exchange for higher credit risk – but cautions that there’s a flip side to buying riskier bonds: “You give away liquidity with these bonds – for example, it will be a challenge to sell your bonds in exchange for cash because not everyone has appetite for risky bonds.”

Not only that, you will also be assuming higher credit risk in the form of the default risk of the issuer of those bonds.

Investing in bonds versus property

“Investing in a bond is not as restrictive as buying property,” says Chang. For one, he says buying and selling bonds is between you and the bond market participants – unlike purchasing property, which involves several parties and higher transaction costs.

Also, some bonds are fairly liquid: “You still have the avenue to get out if you want to – you can redeploy the funds into something else that could fetch a higher return for you.” Ultimately, Chang believes that there is a function as well as risks for different types of investments – “it just depends on your investment needs and risk appetite”.