You will be able to read the terms of a retail corporate bond or perpetual and spot features that move risk onto you.
Kelvin is now looking at two products from the same bank's offering list. One is a five-year retail bond from a property company with a 4% coupon. The other is a perpetual security from a different company, paying 5.5% a year with "first call date in year five". The second pays more, and the word perpetual sounds reassuringly permanent. It is the opposite. Perpetual means the issuer never has to give your money back.
A retail bond is a corporate bond offered to the general public, usually with a minimum investment small enough for individuals, and usually listed on SGX so it can be bought and sold afterwards. Because it is sold to the public, it comes with offer documents: a prospectus, and a shorter product highlights sheet that summarises the main features and risks.
The highlights sheet is where to start. Two sections deserve more of your attention than the coupon.
The first is the use of proceeds: what the company will do with the money. Refinancing existing debt, funding a specific project and general corporate purposes are three different stories about where the company stands. A company borrowing from the public to repay loans that fall due soon is in a different position from one funding a new building.
The second is the ranking: where this bond sits in the queue from lesson 6.1, What happens when a borrower cannot pay. Senior unsecured is the usual ranking for an ordinary retail bond. Anything described as subordinated sits further back.
A perpetual security is a bond with no maturity date. The issuer pays distributions, which work like coupons, for as long as the security exists, and never has to repay the face value. Most perpetuals give the issuer the right to redeem them at face value on set call dates, and the issuer is free to leave that right unused.
Three features move risk onto you.
First, there is no date when your money is guaranteed to come back. If the issuer never calls, your only way out is to sell on the market, at whatever price buyers will pay.
Second, many perpetuals let the issuer defer distributions, meaning skip or postpone them, under conditions in the terms. Some require deferred amounts to be paid later, and some do not. Read the clause and note which kind you are holding.
Third, perpetuals usually rank behind the issuer's ordinary bonds. In a failure, they are near the back of the queue, just ahead of shareholders.
Some perpetuals also have a reset clause: if the issuer does not call on the first call date, the distribution rate changes to a new figure based on market rates then, sometimes plus a step-up. The terms set out the formula.
A call option lets the issuer repay early on set dates. On paper that sounds like a neutral detail, but in practice it works against the holder.
Take a made-up perpetual paying 5% with a first call date in year five. In year five, suppose market rates for this issuer have fallen to 3%. The issuer can borrow more cheaply elsewhere, so it calls the security and repays you. You get your money back just when the best you can reinvest at is lower than 5%.
Now suppose rates for this issuer have risen to 7%, or the company has run into trouble. Calling would mean refinancing at a higher cost, so the issuer does not call. You keep a security paying less than the market rate, and its price falls to reflect that.
So the bond tends to end early when you would rather it continued, and to carry on when you would rather have your money back. The higher coupon is partly payment for giving the issuer that choice. Callable ordinary bonds work the same way, which is why lesson 1.4, Read a bond's terms and fill in its cash flow table, asked you to note any call date under your payment table.
Singapore has a well-known example of how these risks can land on individuals. Hyflux, a water treatment company listed on SGX, had sold perpetual securities and preference shares to the public. In 2018 it applied to the court for protection from its creditors. Restructuring plans fell through over the following years, and retail holders of those perpetuals and preference shares suffered heavy losses.
The lesson is not that every perpetual will fail. It is that the features in the terms, subordination, no maturity and the issuer's discretion over calls and payments, decided who absorbed the losses when the company failed. Many holders had treated the securities as a higher-paying alternative to a deposit. The documents described something different.
Before you buy a retail bond or perpetual, the product highlights sheet answers most of what you need: the ranking, the call dates, any deferral clause and the events that count as a default. Find those four items in one sheet next, and write each down in plain words.
Read the product highlights sheet of one retail bond or perpetual and list its ranking, call dates, any deferral clause and what triggers a default.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).