In this edition of the podcast, Mohammed Ali Yasin, Head of NBAD Securities, discusses equity markets in the region following 3Q results and shares his expectations for the remainder of 2016. In a segment called “Back to Basics”, Alain Marckus, of NBAD’s Global Asset Management, explains the concept of bonds and the principles of investing in bonds. This episode is hosted by Michael Miller, Head of NBAD’s Investor, Media and Public Relations and Nathalie Gillet, the Editor of NBAD’s Marketing and Communications team.
NBAD Insights Podcast
Read the written version of the podcast's segment 2:
Back to Basics - Bonds
(Interview with Alain Marckus)
NBAD Insights: What exactly is a bond?
Alain Marckus: “The investment market is quite vast. There is a whole range of instruments out there to choose from when you are an investor. Bond markets are one of them. Traditionally Governments around the world have been borrowers. They need to raise money to fund their various development programmes or infrastructure projects for example. They can do so via bond markets. They issue a bond an I-O-U so to speak. Investors can then acquire these against interest received. We call these bonds. ‘Sovereign bonds’ can be issued in local or foreign currency. But companies borrow in bond markets too. We call their bonds ‘corporate bonds’. Effectively, investors become like lenders to the government or the company that is issuing a bond. And just like a bank receives an interest for providing a loan, investors receive a fixed amount of interest - also called a coupon - for the bond that they have purchased. This interest is generally fixed at a particular figure that does not vary - unlike dividends that are paid to equity shareholders and can vary on the fortunes of that company. That is why bonds are called fixed-income instruments. There are also specific types of bonds to meet the interests of specific groups of investors, such as green bonds for environmentally aware investors; or Sukuk - Islamic bonds – for people looking at Islam friendly instruments.
In what currency are bonds generally issued?
Bonds are issued in many different currencies as well as countries. The US Dollar is the most dominant as well as the most widely traded. Borrowers can issue in any market around the world. NBAD for instance recently issued a bond in Taiwan. It’s generally good for an issuer to demonstrate that they can tap funding anywhere in the world. While introducing local investors in the market to the company it also diversifies a company’s funding requirements.
Can anyone invest in bonds?
Yes. This market is available to all types of investors in the same way global stock markets are. But bonds tend to have minimum sizes – generally more than USD100,000. It was a market initially aimed at the institutional investor. Over time, it has got a wider following amongst private banking as well as retail. It generally suits more ‘priority banking’ clients, meaning investors with a net worth of a million dirhams or more, whereas the man on the street who has a couple of thousand dirhams to invest can still get easy access to the stock market but may find the bond market more difficult. For smaller investors like these, a good way to play these markets would be bond funds that offer diversification through a pool of bond investments. Some of our clients for instance say “I am interested in this bond but I only have a million dirham”. Rather than buying the ‘single line’, they can simply go into a bond fund that mirrors buying a single line. A bond fund is more diversified and more suitable for the smaller investor. Most banks have this type of offering.
How do I invest in a bond? Where do I go? Who do I talk to?
This is a simple and straightforward question with a very unusual and difficult answer. The main fundamental difference between a bond and a local stock is that for local stocks you can go to any securities house down the road - or pick up the phone - open an account and just buy and sell. Bonds generally trade over the counters (OTC)*, which means that they are not traded on exchange. This is something a relationship manager at a bank can help you set up.
What is the risk level of bonds?
Like stock markets, bond markets have varying degrees of risk. This affects the level of interest payment that can be earned. The higher the risk, the higher the payment. Commonly referred to as the risk versus reward. Once a bond has been issued, it trades at prices that can move up as well as down, according to supply and demand. When the bond comes to maturity (the date on which the investor needs to have his money returned to him), this is the moment the issuer pays back the initial price paid for the bond – the ‘par value’ or ‘face value’- to the bond holder. Because it is fixed income, bonds are generally considered a safer asset class than stocks or shares. But there are different types of risk in bonds too. There are Promissory notes more commonly known as Debentures. This is the least risky form of borrowing known as ‘secured debt’ where a borrower will pledge assets to give the lender more comfort. There are also unsecured bonds - the most common ones - where the lender assesses whether the issuer has the ability to repay the borrowing. Then there is the riskier end of the market called high yield bonds and subordinated bonds where the rate the borrower pays is much higher than secured lending but can be equivalent to equity share risk. This is far riskier than your normal bond. The quality of the underlying issuer will also determine the rate paid to the lender. A small corporate issuer, for instance, will have to pay a higher coupon per annum for borrowing than the least risky borrower, such as a developed country’s government for instance. And this is reflected in the rating of the bond.
When do I get paid with a bond?
Most bonds are semi-annual. Also, if you buy on day 100, you get 100 days of interest, which is very different to equities. In the equities market some investors for instance just ‘coupon strip’, as they call it, which is buying a share just before the coupon – or the dividend - is paid and then they sell. Bond markets do away with that. They pay however many days of interest you are due in that particular point of the year.
Alain Marckus, Director - Investment Strategy - Global Asset Management
*In an OTC market, dealers quote prices at which they will buy and sell; a trade can be executed between two participants without others being aware of the price at which the transaction was effected.
This podcast was recorded on 03 November 2016. All the price references and market forecast correspond to the date of recording. This podcast should not be copied, distributed, published or reproduced in whole or in part. The information contained in this podcast is not to be considered as an offer or recommendation to buy or sell any financial instrument or banking services. The views expressed in this podcast have been presented without regard to the individual financial circumstances and objectives of persons who receive it. Neither the National Bank of Abu Dhabi PJSC (“NBAD”) nor any of its subsidiaries or affiliates (including NBAD Securities (“NBADS”)) nor any of their representatives makes any representation or warranty, as to the accuracy or completeness of the information contained in this podcast.
Any liability whatsoever including in respect direct or indirect or consequential loss or damage is expressly disclaimed. The securities and products mentioned in this podcast may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances, objectives and risk profile. Many factors may affect the value of a financial instrument. Investors shall therefore conduct their own analysis of the risks - including any legal, regulatory, tax or other consequence - and benefits associated with a transaction in a given financial instrument and should seek independent professional advice. NBAD is licensed and regulated by the Central Bank of the UAE. NBADS is a subsidiary of National Bank of Abu Dhabi PJSC and is licensed and regulated by the Securities and Commodities Authority (registration number 604002).