Monday 27 April 2020 by Elizabeth Moran Top 10 tops for assessing bonds Education (basics)

Top 10 tips for assessing bonds

This month, Glencore, a diversified multinational commodity trading and mining company, issued a bond in the domestic market for the first time. The company has a market capitalisation of around $50 billion and is the nation’s largest coal producer through its Australian subsidiary Glencore Xstrata.

The bond is a senior unsecured fixed rate bond that has a five year term and matures in September 2019. The fixed rate of interest at first issue was 4.75%.

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This article will concentrate on how to assess a bond, using the Glencore bond as an example.

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 does the bond sits in the capital structure This bond is senior unsecured, which means it sits at the senior debt level and in the case of a 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.
  3. Check if the bond is fixed, floating or inflation linked The Glencore bond is a fixed rate bond and the interest payments to you will not change over the life of the bond. Interest payments are 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). While most inflation linked bonds also pay a fixed rate of interest but on an increasing capital value that rises with inflation.

  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. Decide if you can buy the bond The vast majority of bonds are traded in the over the counter 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. But wholesale investors have a greater range of bonds to chose.
    The Glencore bond was issued in the wholesale over the counter market and was 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 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 compared 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 and what are the returns on offer? Is the return on the senior bond what you would expect given returns on these other investments?

  10. Assess the relative value compared to other bonds from similar companies What rates of return are available from companies in the same sector and or similarly rated companies? One possible comparator is Adani Abbott Point, which owns the Abbot Point Coal Terminal located 25kms north of Bowen Queensland.The terminal is one of the largest coal terminals in Australia. Although this company’s credit rating is lower than Glencore, its May 2020 bond pays a 1.21% premium over the Glencore bond.

The Glencore bond was attractive to wholesale investors as it met the above criteria. A good bond broker should be able to provide you with research on the bonds they trade. This list will help you determine if the bond suits your portfolio and can be used to ask your broker questions.