This article was originally published in The WIRE on 1 October 2014 and again on 4 October 2016
There are a number of factors to consider when assessing a new bond investment – not just the return
A few years ago, Glencore, a diversified multinational commodity trading and mining company, issued a bond in the domestic market for the first time. At that time, the company had a market capitalisation of around $50 billion, and was the nation’s largest coal producer through its Australian subsidiary, Glencore Xstrata.
The bond is a senior unsecured fixed rate bond, which has a five year term and matures in September 2019. The fixed rate of interest at first issue was 4.50%.
This article focuses on how to assess a bond, using the Glencore bond as an example. Our top 10 tips for assessing bonds:
1. Assess the “survivability” of the company
Do you think the company will be able to survive for the term of the bond and thus pay you interest and return face value at maturity? A company the size of Glencore, with its significant assets, would likely mean survivability for the five year bond term is high.
2. Understand where the bond sits in the capital structure
This bond is senior unsecured, which means it sits at the senior debt level. This level, in the event of wind up, means that subordinated debt, hybrids (if there are any) and shares that rank below must be wiped out completely before you would incur a loss. This gives investors some comfort – and Glencore’s large market capitalisation provides an excellent equity buffer against loss, should the company default on one of its payments.
Source: FIIG Securities
3. Check if the bond is fixed, floating or inflation linked
The Glencore bond is a fixed rate bond and the interest payments will not change over the life of the bond. Interest payments for a fixed rate bond are mostly half yearly. Are you looking to add to the fixed rate component of your portfolio, or is your allocation high enough? If your allocation is full, you’ll need to consider selling other fixed rate assets or perhaps waiting until a term deposit matures before you invest.
Floating rate bonds pay variable interest linked to a benchmark such as the bank bill swap rate (BBSW).
4. Check the term to maturity
There is a large secondary market where bonds are traded, but if you are a hold to maturity investor, you’ll need to make sure the maturity date suits your portfolio.
5. Determine if you can buy the bond
The vast majority of bonds are traded in the over the counter (OTC) market and you need to find a bond broker to trade on your behalf. Over the counter bonds are available to retail and wholesale investors, however wholesale investors have a greater range of bonds to choose from.
The Glencore bond was issued in the wholesale OTC market and is only available to wholesale investors through a bond broker.
6. Assess the return given the risks
Every bond and company has risks, do you know what they are and do the returns on offer adequately compensate you for the risks involved?
7. Check the size of the issue
The larger the issue, the likely greater the liquidity, as there will be a larger number of investors that hold the bond and it will be included in bond indices. The Glencore bond raised $500 million on issue and given the size, we would expect it to have good liquidity.
8. Confirm the bond has a credit rating
This will give you an indication of the risk involved. The higher the credit rating, the lower the risk. The highest investment grade credit rating is “AAA”, others include “AA” “A” and “BBB”. The last three categories can also have a “+” or a “-“ attached to them. The lower the risk, the lower the expected return. Non investment grade is anything rated “BB+” or lower.
Glencore has an investment grade credit rating, and it is considered low risk. It’s important to note that in Australia, only wholesale investors can be told the credit rating.
9. Assess the relative value to other company investments
What returns are available on other investments in Glencore’s capital structure? Does the company issue senior secured or subordinated debt? Is the return on the senior bond what you would expect, given returns on these other investments?
10. Assess the relative value compare to other bonds from similar companies
What rates of return are available from companies in the same sector and/or similarly rated companies?
At the time the bond was issued, it was attractive to wholesale investors as it met the above criteria.
This list will help you determine if a bond is suitable for your portfolio and can be used to ask your broker questions.