A bond is a type of asset that allows you to earn interest for the money that you allow to be borrowed to an institution, generally businesses and the government. Investing in them in the Philippines can be an option for certain types of investors. They are usually described as containing less risks than other aggressive assets such as corporate stocks.
But what is a bond? How does it let you earn passive income? And how does it compare to other ways in making your money grow?
This article is a beginner’s guide to bonds that are available for investing in the market in the country. It is going to discuss the different types that you’re going to encounter today, the various benefits that you can get out of them and how can you start investing.
What is a bond?
A bond is a debt. It is issued as proof that a company or organization borrows a sum of money from an investor, so it is an evidence that acknowledges a debt has been made. It can be considered as an obligation where the company provides the details of the loan and the payments. When a company announces that they’d like to borrow money, they are said to issue bonds so they’re called issuers. Investors who acquire them are called debt-holders or creditors.
Why do companies issue bonds?
They are issued as one of the options to raise funds. The other options include going into a loan agreement with banks or to sell corporate stocks. The capital that they raise goes to different expenditures. The government may need the money for public spending to build infrastructures such as roads and bridges, or to finance important social services such as education and healthcare.
For private corporations, they’d spend the funds that they got to ensure they have enough cash for expansion, research and development, increasing manpower, sustain operations etc.
Both of these institutions may also use it to pay for existing maturing debts.
Who regulates bonds?
In the Philippines, corporate bonds are regulated by the Securities and Exchange Commission.
What is the difference between bills, bonds, and notes
They all are debts. They differ mainly by the maturity and whether they can be sold or bought on the secondary market. Bills have shorter terms ranging from months to less than one year, while bonds and notes have longer terms usually stretching more than a year to decades. On the other hand, bonds almost always can be traded while notes may not always be held as trade-able securities.
Another key difference is that bills are usually purchased at a discount and redeemed at face value, unlike bonds and notes that are acquired at face value. What does this mean? It is better understood with examples. Treasury bills, for instance, do not give out interest. Instead, you gain from the difference between the discounted price and face value, which is called the spread. You can get a treasury bill for ₱95, and then when it matures you’d get paid ₱100. The ₱5 difference (100 – 95) is the spread and your gain.
As comparison, bills and notes are acquired at face value and give out periodic interest.
How do bonds work?
How can you make money in bonds? Just like any other debt, investors are entitled to get something for allowing their money to be borrowed.
Investors can acquire them by putting up money. The issuers would set a minimum amount, which is the lowest required sum that is allowed. A retail treasury bond such as the Premyo bonds issued in 2019 can be had for as low as ₱500 per bond unit, while corporate bonds are up for grabs ranging for at least ₱50,000 to ₱100,000.
If investors would like to get more, they can do so by paying at increment, which is the lowest amount required for additional bonds. Going back to the example of Premyo bonds, the public can get more by buying additional bond units at the required increment of ₱500. In contrast, there are corporate bonds that would require at ₱10,000 to ₱50,000.
Those who hold them can expect to receive interest, also called coupon, every year expressed in percentage. The interest is paid out generally every three months (quarterly), every six months (semi-annually), or any other frequency. It is set before it is issued and remains the same, so bonds are thus considered fixed income. All earnings are subject to 20% capital gains tax.
The RTB 2020 issued by the Bureau of the Treasury during the first quarter of 2020 has a coupon rate 4.375% with a maturity of three years. It is paid quarterly that is deposited straight to your bank account. So if you’ve invested at least a million pesos, this is how much your quarterly earnings, total earnings, cumulative gain and CAGR would be.
|Taxed quarterly interest||8,750.00|
|Taxed annual interest||35,000.00|
|Total earnings when held until maturity||105,000.00|
The interest however is stopped at maturity (also called tenor or term), which is the length of time that the bonds are expected to be paid back by the issuer. It usually lasts as short as two years and as long as 20 years (or even longer), and is described by the following:
- Offer date is the range of days that the bonds are being offered.
- Issue date marks the start of the term.
- End date marks the end of the term.
- Maturity is the period between issue date and end date. So if the issue date is January 31, 2020 and end date is January 31, 2023, then the maturity is three years.
When they mature, the investors can receive any remaining unpaid interest and get back the capital that they’ve lent. The failure for the company to pay interest and return the capital back to the debt-holder is defaulting on their debt obligation.
Not all the time that investors are expected to hold the bonds until the end date. They have the option to go to the secondary market, called Philippine Dealing and Exchange Corporation (PDEX) where they can sell their holdings.
What are different types of bonds available in the Philippine market?
There are two general types of bonds that you can acquire: government bonds and corporate bonds.
Government or treasury bonds
Government bonds are issued by the Philippine government through the Bureau of the Treasury, and that explains that they are also known as treasury bonds. They are offered in two different ways: through auction and directly to the investing public. In auctions, the bonds are held up for bidding commonly to institutional investors who would then have the option to make it available to the general public.
On the other hand, the Bureau of the Treasury also sell directly to the public without going through the bidding process. Examples are Premyo bonds that were issued in the last quarter of 2019 and the RTB 2020 as mentioned earlier.
Government or treasury bonds are considered to have the least risks, and that is because they are backed by taxpayers. The risk of default is relatively low. However, it is also important to bear in mind that some countries in the world have defaulted on their debts in the past. Argentina for example defaulted on its foreign debts in 2001.
Corporate bonds are issued by private corporations that are publicly listed on the stock exchange. Announcements are made in major broadsheets and newspapers in the country, inviting investors who may want to get them.
Advantages of bonds
What are the benefits when investing in bonds? There are many advantages that these types of investments have over other income-generating options.
- Fixed income. The issuer is going to pay predictable interest periodically. The interest can be paid quarterly, semi-annually or any other frequency.
- Less volatile. There is less volatility with bonds compared to holding stocks, and that is because the income from them (which is the interest) are already known and fixed from the beginning. The same cannot be said with stocks. The value of stocks change and it is difficult to predict its future stock price over time.
- Comparatively less risky. If a company goes bankrupt, whatever assets it has left will be liquidated to pay its debts. Since bonds are essentially debts, bond-holders are given priority to be paid first than those who hold stocks. Government bonds are generally perceived to have the least risks because they are guaranteed by
- Liquid. If you want to get your capital back before the term ends, you can do so by selling your holdings on the secondary market. Similarly, if you want to acquire bonds
- Diversify risk portfolio. Bonds are a way to disperse risks in a given investment portfolio. It gives you exposure to less volatile assets that provide periodic income.
- Interest is better than banks. Most of the time, the income that you can potentially derive from bonds through interest payment is higher than the ones provided by bank accounts such as savings account or time deposit.
What are the risks in bond investing?
But what are the disadvantages? Remember that all forms of investing have risks, and that is true with bonds as well.
- Taxable. Whatever you earn from them is subject to capital gains tax of 20%. You don’t get the entire interest as your income earned, unlike in long term negotiable certificate of deposit (LTNCD) when held to maturity.
- Risk of default, also called credit risk, is a situation where the company cannot pay the interest on the due date or the principal amount on maturity. That’s why credit ratings companies exist such as Standard & Poors and Philippine Rating Services Corp. (PhilRating) that assess the credit-worthiness of the companies and their issued bonds.
- Interest rate risks. When interest rate (which is set by the Bangko Sentral ng Pilipinas) increases, the yield that you get from bonds decrease. That is because the new and higher interest rate becomes more attractive than the interest given by long-term bonds.
- Liquidity risks. There might also be a concern on how quickly you can trade (buy or sell) the bonds to the second market particularly when yields are not attractive due to high interest rate.
- Inflation risk. When inflation spikes, the purchasing power of the fixed income that you get is lessened.
- Reinvestment risks. When the central bank lowers the interest rate, your earnings when you reinvest the fixed income derived from bonds may also be less. Also, there are callable bonds where companies can decide to pay back investors to take advantage of low-interest years. They choose to settle the long-term, high-interest bonds in order to borrow money at less interest.
- Opportunity risk. Studies show that stocks outperforms bonds in the long term, and yet during market volatility and recessions bond yields can be attractive.
Is investing in bonds right for you?
Bonds can be an option for anyone who do not want to be exposed to the volatility of stocks, and instead they prefer to received predetermined and predictable income from interest. Experts also recommend them when investors would like to have lesser chance of capital loss than stocks. So they can be suitable for investors who are conservative and do not like substantial risks in their investments as well as for those may need to receive periodic earnings, such as retirees.
What is the potential earnings of bonds?
How much can you possibly earn from bond investing? Your potential earnings are limited to the interest that is set when you acquire them and the taxes. Interest is higher the longer the maturity is, and it is generally lower when it the maturity is shorter. Other factors that might also affect your income would be the prevailing interest rate, inflation, credit-worthiness of the issuer, etc.
In the table below, you will see estimated earnings in a range of interest rates from 3% to 8%, and they are already computed with 20% tax. You can also see the cumulative gain which is just the result of dividing your capital plus all interest earned through the years over your capital.
And you will also see the CAGR or the compounded annual growth rate, which is the effective compound interest. This can be used to compare with other options in the market. So for example, under 3%, your CAGR is 2.17% which is higher than savings accounts and some short-term time deposit.
How can you invest in bonds?
There are many ways to acquire bonds depending on the timing: within offer period, through Bureau of the Treasury and authorized partners; outside of offer period, you can invest through the through the secondary market and through bond funds.
Regardless on how you acquire them, there are basic requirements that you need to prepare.
- Valid identification cards
- Tax identification number or TIN
- Minimum capital
- Bank account where your interest and, upon maturity, your capital are going to be deposited
Through Bureau of the Treasury and authorized partners
If the treasury and corporate bonds are within offer period, you can acquire them through the Bureau of the Treasury or authorized partners, which are usually banks and investment houses.
How do you know that they are up for grabs? They are usually announced within the business sections of newspapers and broadsheets. You can just go to the Bureau of the Treasury website for further instructions. Check out this article as well on retail treasury bonds.
Through the secondary market
But what if you are late into the game and you want to buy them after the offer period? Don’t worry. You can do so through the secondary market, which is the Philippine Dealings and Exchange Corporation (PDEX). You would need to open an account with brokers, and fees are going to be charged when you trade through them.
- Allied Banking Corporation
- Asia United Bank
- Asiatrust Development Bank
- Banco de Oro Unibank, Inc.
- Bank of Commerce
- Bank of the Philippine Islands
- BDO Private Bank
- China Banking Corporation
- Chinatrust (Phils) Commercial Banking Corp.
- Citibank, N.A.
- Citibank Savings, Inc.
- Citystate Savings Bank
- Deutsche Bank
- Development Bank of the Philippines
- East West Banking Corporation
- Export and Industry Bank
- Hongkong and Shanghai Banking Corp.,Ltd.
- ING Bank
- JP Morgan Chase Bank, National Association
- Land Bank of the Philippines
- Maybank Philippines, Inc.
- Metropolitan Bank and Trust Company
- AIG Philam Savings Bank
- Philippine Bank of Communications
- Philippine Business Bank
- Philippine National Bank
- Philippine Veterans Bank
- Planters Development Bank
- Rizal Commercial Banking Corp.
- Robinsons Savings Bank
- The Royal Bank of Scotland (Philippines), Inc.
- Security Bank Corp.
- Standard Chartered Bank
- Union Bank of the Philippines
- United Coconut Planters Bank
- AB Capital and Investment Corp
- BPI Capital Corporation
- First Metro Investment Corporation
- Multinational Investment Bank Corporation
- BDO Capital and Investment Corporation
Buy bond funds
Lastly, you may also indirectly own them bond funds. Bond funds are investment funds that are managed on your behalf, so you don’t have to spend the time or learn the skills in trading them. You can actually open any of the following accounts: mutual funds, unit investment trust funds (UITF), Personal Equity and Retirement Account (PERA), or variable universal life (VUL) policy.Tags