Investing in a low interest rate environment can be very challenging. Investors are actively seeking new types of instruments to place their hard earned life savings. They will sometimes overlook many obvious risks just for the sake of earning high returns and it turns out that there are many new and different structured investment instruments out in the market. We have seen a lot of new issues-including Local Corporate and International Corporate bonds issued recently and with that in mind, we will examine the pros and cons of investing in these instruments.
Local Corporate Bonds are issued through local institutions (Jamaican/Caribbean entities) from time to time and are generally sold only to accredited investors. Accredited investors are so described when their net worth is J$50m and over or they are investing a minimum of US$100,000. It is also believed that this type of investor is better able to take on risk either because of a higher level of sophistication/knowledge and/or a larger financial cushion to handle losses.
Locally issued bonds have the advantage of being readily recognizable by local investors. This familiarity leads to an increased willingness to participate in such issues and a tendency to overlook any details pertaining to the credit worthiness or even basic financial strength of the issuer. This is further compounded by the peer pressure that is likely to occur, given that friends may also be investing, so there is strength in numbers type of mentality.
Some of the challenges experienced with locally issued bonds may include issues related to the currency of the bond, some relate to the currency of the ultimate borrower, liquidity and tradability to name a few. You have to pay attention to the currency that is being used which varies from local currency, to US currency to indexed bonds (i.e. indexed to the U.S. currency). Check carefully, if the entity paying back the loan is based in a country (for e.g. Trinidad or Barbados) with strict currency controls. Many times a buy and hold strategy is very straight forward, however, if you wish to come out of your bond, it may be at a substantial discount if at all, i.e. there may not even be a market for that bond at the time you need to sell (in part or in whole).
International Corporate Bonds are bonds issued by foreign companies and are normally issued in US dollars. This may or not be the currency that the company earns. The challenge with these types of bonds is the opposite of local bonds, i.e. many times investors are simply not familiar with the companies and are therefore highly reticent to invest their funds. This means that it is that much more important to research the company thoroughly before investing. However, there are several advantages: the first being that these companies are usually rated, so it makes it a little easier to assess their credit worthiness. Secondly, the companies, on reaching the international market, are usually far larger than local companies. The size normally means increased cash flow and capacity to pay and access to far larger markets. These companies are traded often, and getting in and out is normally much faster than local companies.
When choosing to invest internationally, consider the political risk if any, as well as the ease with which you can access information on the company. For companies that are publicly owned, it will always be easier to obtain information on their performance, than privately owned companies.
Your next question may be: why do I have to choose? Can’t I have both? The simple answer is yes, you can have both, in fact it is certainly useful to build a well-diversified portfolio. However, no matter what you are investing in, it is critical to do your due diligence and take a long hard look at the 4 Cs of credit, the character, the capacity, collateral and capital.
Diversification plays a huge role in investing in corporate bonds in general. International bonds can balance out some of the portfolio’s risk. Give some thought as to what kind of risks you are willing to take, given the nature of your other investments and - together with your advisor - consider exploring the wide world of global bonds. The risk may be worth the reward.