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Lessons learnt from the recent bond saga

Following the default of Swiber in July and a series of debt-restructuring meetings between several offshore and marine (O&M) companies and note-holders, investors are starting to come to realise that buying into notes and bonds are not the problem-free passive incomes that they had expected. Most of these meetings end up in deadlocks that drain a lot of time and energy. Interestingly, the holders of these notes are the High Net-Worth Individuals (HNWI) who purchased the notes through their respective private banking channel and are well served by relationship managers. Most of these clients are likely business-shrewd, financial savvy and have gone through many financial challenges in life to see through things before they reach this pinnacle to be a private banking client.
Are the banking clients so trusting that they simply entrust at least a quarter million dollars of their money to relationship managers without asking critical questions? Do they do the same when they buy a pair of $100 shoes or to sign up for a course for $1,000 or purchase a $200k car? Or is it that the promised rate of return is so glaring that everything else got obscured. Surely, a relationship manager (or anybody) who tries to sell us something cannot be on the same side of the negotiating table as us in a buy-sell transaction.

Ironically, most of the Investment instruments are built such as that once we get into it, there is always a price to get out, be it time, money or effort. Essentially, there are three critical factors to look into:

a. The exit plan: One key thing in investment is to know, understand and even plan the exit strategy in case the investment did not turn out as expected. If an investment does not offer as easy exit as the entry and subjecting it to a huge capital loss, then it is never a good investment no matter how good the promise can be. This does not only apply to corporate bonds, it also applies to direct selling, gold trading and land-banking investments as well. I learned this important lesson during the Asian Financial Crisis (AFC) when the Malaysian authority was about to impose currency control on the Malaysian Ringgit. During the last few days before the CLOB was closed, even good stocks were offered at steep discount. Imagine, stocks like Malayan Banking Berhad (MayBank), bought at more than S$4.00 during normal times were trading at around 70-80 cents on the very last day of the CLOB trading. This was how I learned this expensive lesson. In the case of the corporate bonds, there are basically two ways of exiting the investment, that is, either to hold the bond till maturity or to sell them off mid-way in the secondary market. Given the relatively low interest rate environment, it is very likely that most note-holders are planning to hold the bonds till maturity. In other words, there is not much liquidity in the secondary market. Furthermore, during times of crises, most of these note-holders will be at the sell side, and it is likely that existing note-holders will suffer a huge capital loss when there are no urgent buyers. So, there is almost no chance of exiting the investment midway without suffering heavy losses in the capital.

b. Rate of return:The rate of return has always been the best selling point to attract bond buyers especially with the current meagre bank interest rate. But it is also a point to ponder why companies are willing the dish out 7% (or whatever attractive percentage) when the banks are paying only 1% interest. Chances are that secured lenders like banks have decided that it is becoming too risky to continue to lend to the company, and these companies may have no choice but to turn to issuing bonds, a form of unsecured lending to get the funding that it needs. The relatively long period of low interest rate had set a stage for excessively borrowing by the companies, and all it takes is a critical factor, eg., a crash in the oil price, to knock off the company financially. It is really a high gain high risk situation that many people may not realize until it happens.

c. The liquidity factor – The primary objective of people investing in bonds lies in the hope to hold the bonds till maturity without default on the coupons and the final principal. So, in general, corporate bonds are not liquid. A good indication is the significant difference between the bid and offer spread. This means that if the bondholders sense something wrong with the issuing company, it is not easy to sell the bonds in the secondary market without a huge discount. Furthermore, note and bondholders are likely discrete individuals and it is difficult to get into a collective bargaining with the bond issuing company on equitable terms. Administratively, it is difficult to get all the bondholders together, let alone the fact that such efforts involve additional costs and time to seek legal redress.

To sum up, it is no longer a situation that one can sit back, relax and collect high passive returns just like that of one year ago.

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.