Corporate Bonds, Preference Shares, Reits – How to decide?

Contributed by: Warriortan,

#investforyourself, #fixedincome, #bonds, #preference shares, #Reits

Are you a relatively conservative investor that are happy to receive a stable, regular and decent return BUT are not so risk adverse as to want to park your money only in “risk-free” investments like government bonds, fixed deposits etc?

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Then these investments types may interest you: Corporate Bonds, Preference Shares and Reits.

I am one such investor and I am vested in all 3 types 😊

This post is a response to a reader’s request for a comparison between preference shares and Reits. I have added corporate bonds to this comparison for completeness because I think these 3 types of investments will interest low-moderate risk investors.

For more information about corporate bonds and reits, you can find them on this link

Paraphrasing a definition from Investopedia – A preference shares is a class of ownership in a corporation that has a higher claim on its assets and earnings than common shares. Preference shares generally have a dividend that must be paid out before dividends to common shareholders can be distributed. But holders of preference shares has no rights to vote in major company decisions. Preference shares is unique in a way as it combines the features of debt and equities – fixed dividend rate and yet has the potential to appreciate in price.

In some ways, the 3 of them are similar – they are linked to companies (not Government), they can be bought and sold readily in the market, they provide a regular dividends/coupon payment.

But in reality, they are very different.

The choice of the investment types depends a lot (still) on your investment objectives, risk appetite and capital outlay … just to name a few.

Before I go into the nitty gritty, let me share some examples of such investments listed on SGX:

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Retail Corporate Bonds:

  1. Capitaland Mall – CAPITA 3.080% 20Feb2021 Corp (SGD)
  2. Fraser Centrepoint – FCLSP 3.650% 22May2022 Corp (SGD)
  3. Perennial – PREHSP 4.550% 29Apr2020 Corp (SGD)

These are termed as RETAIL corporate bonds because we can buy them in par value of $1000 per lot. Most other corporate bonds come with a par value of $250,000 minimum per lot and they may only be available to accredited (not retail) investors.

Retail Preference Shares

  1. DBS – DBSSP 4.700% Perp/Callable 2020 Pref (SGD)
  2. OCBC – OCBCSP 5.100% Perp/Callable 2018 Pref (SGD)

These specific preference shares have a “perpetual” lifespan which means that the company may choose to keep the preference shares forever and not “call” it on the callable date. 

Reits

Do I need to introduce Reits listed on SGX? Well, I think there are plenty of posts around Reits around … even in my blog … so I will skip πŸ˜‚

So, how do you choose and how are they different?

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Like I mentioned earlier, I am vested in all 3 types. The reason is purely for diversificationand they suit my investment objectives. I want to diversify between asset classes, between industries and between countries. The broader the diversification, technically the lower the risk of your investment to lose “big time”. But the converse is also true, you won’t gain big time. 

I am happy with a 3-5% year-on-year yield, so I guess this strategy works for me.

If you are looking for a bigger gain then you will need a higher concentration of high yield instruments and may also need to partake in some form of speculation.

But even within these 3 types of investments, you can still make a choice. 

So what are those considerations?

(I like to mention that my views are linked to those SGX listed retail corporate bonds, retail preference shares and Reits only. In some ways, they can be generalised but please use with care if you do so out of the Singapore context)

Risk Level & Rate of Return

This is the main consideration. In an ascending order of risk level, I would say its retail corporate bond, preference shares and Reits.

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Retail Corporate Bond has the lowest risk because of the following reasons:

  • You get paid fixed amount of coupon payment first before shareholders (even before preference shares)
  • There is an end date to these bonds – hence, it limits your time exposure.
  • Even if the company collapses and there is still money, you will get paid first before the shareholders

I know there is a lot of flak related to gas and oil bonds recently as they struggled to make the coupon payment or redeem the bond as required. However, it is not the fault of this investment type but rather the underlying strength of the company.

Hence, the choice of the company is important. Besides the 3 retail corporate bonds that I mentioned above, there are a few others. However, I am less keen on those as I feel they contain more risk that what I am willing to take.

The other risk that is common to all bonds is its inverse relationship with market interest rate. If the bank offers a higher FD rate, then such bonds will be worth less because people are more willing to sell them to put their money in FD instead. When that happens, you may suffer a loss if you sell the bond. 

But if you are happy with the interest rate and don’t sell it, you will continue to collect fixed coupon payments at regular interval and be able to get back your principal when the bond expires. The company will have to pay you first because if they don’t, it is considered a default. 

So, in some way, when you buy a bond, I think you should consider the possibility of holding it to maturity. Any less you run the risk of losing money.

Having the lowest risk also means that they usually have the lowest return for the same company.

Please note that the interest rate on the name of the bond gives you the coupon payment you can expect. It can be different from the actual yield that you get from these bonds as you may purchase the bonds at higher cost (i.e. Lower yield).

Preference Shares is in the middle – it is somewhat like a bond but holders of preference shares rank lower than bond holders but higher than common shareholders.

For the 2 retail preference shares that I mentioned above, they are issued by our big, strong local banks so I can sleep well while owning their preference shares. One thing about them that you should take note is that they are perpetual preference shares, i.e. there is no fixed commitment from the company to redeem these shares on a certain date. Hence, your money will stay there as long as you don’t sell. From the risk perspective, it is not good as you are exposed to unlimited time horizon. But if you are happy with the interest rate and the company can fulfill its commitments, then its ok πŸ™‚

One important safeguard for holders of preference shares is that the company will have to pay you first before they can pay their shareholders.

Note that similar to bonds, its value is also affected by interest rate.

Because of its moderate risk – its return is sandwiched between the other 2.

Again note that the interest rate on the name of the preference shares gives you the dividned payment you can expect. It can be different from the actual yield that you get from these preference shares.

Reits has the highest risk among the 3.

REITs

It is an actual company that you are investing in and thus you are exposed to every risks that the company has. There is no commitment from the Reit to pay you dividend, no commitment in the dividend rate and you will rank last in the pecking order in receiving any money back if the company collapse. Earlier on, Saizen Reit suffered from that before a white knight came along to buy out the company and “saved” its shareholders.

Furthermore, as the name implies, Real Estate Investment Trust is a real estate company. So, its business revolves around making money from the real estates that it owns. It typically borrows heavily to buy properties and then rents them out to collect the rental fees. It is from the rental fees net operating cost that it returns to you as dividends. Hence, the business risks come in 2 major forms – the ongoing value of the assets and the ability to rent the property space out for income.

Also because it borrows heavily, it is very sensitive to interest rate.

But having said that, because it is a more risky investment type than the other 2, it typically provides a higher rate of return to its owners.

One common vibe about Reit is that it will have to seek money from its owners to fund its growth and acquisitions. This is because it doesn’t keep any cash and it cannot borrow indefinitely. The Singapore listed Reit has a limit of 45% gearing for Reits. Because of this limit, some say that Singapore Reits are generally safe.

Reit doesn’t have much cash in its balance sheet because it has to return >90% of its cash inflow as dividends to you in order to qualify for tax exemption for you. So, one of the aspects that I look into Reits is how much they have seek money from shareholders versus the amount of the dividend they distribute over a 3-5 years horizon. If the former exceeds the latter or come very close, I will be more wary of that Reit. See this post.

Unlike bonds and preference shares which provide “fixed” return, Reit functions like a company. It can grow in size and increase its value over time by managing the asset well to make more money, acquire assets in an opportune timing and obtain exceptionally low cost funding. Hence, it may offer you a greater return. The reverse is true, it can also collapse under the weight of its debt and/or poor management and your return will be diminished. The last financial crisis in 2008/2009 crushed a few Reits and it was a painful lexperience/lesson for their shareholders.

The relationship between high risk high return is universally true.

So what now?

In my view, I think all 3 have a place if we want to build a diversified portfolio.

To me, the availability of retail corporate bonds issued by financially strong companies is a blessing. I hope the authorities or GLCs can do more of this as a corporate social service to Singaporeans. Most corporate bonds require a minimum investment sum of $250,000, which is out of reach for many of us and even if you have the cash, you may not want to put all your eggs in a single basket.

So, for retail corporate bonds, I will keep a lookout and will be sure to subscribe to it if the coupon rate is reasonable. However, I will avoid corporate bond from companies that are financially weak, risky industries and small SME.

For preference shares, there are not many retail choices in SGX to start with. Those 2 that I mentioned above are good ones that you may want to consider. In general, I do not like perpetual shares as there is no end date in which i can safely assume that I will get my principal back. However, I will consider them if the coupon rate is attractive and the company is financially very strong.

For Reits, I will evaluate it like a normal company. I like having the opportunity to be a landlord and collects rent on a regular basis – this is the ultimate passive income to me. I will however, avoid companies with very high gearing, poor management, keep acquiring assets that are not yield improving or have a majority shareholder/sponsor who will “bully” minority shareholders to absorb assets into the Reits at above market prices.

In order to further reduce the risk level of investing in these assets, you can consider ETF of bonds, preference shares and Reits. With an ETF, one company’s failure will not make a major dent in your portfolio values.

There are a few of them listed on SGX. They are available to retail investors and they do offer a very good form of diversification. See below

Bonds ETF

Reits ETF:

I don’t think there is a ETF for preference shares on SGX. There are some in US if you have the option to purchase them.

As always the Choices of investment are personal.

In my case, my investment aim is simple, I want a portfolio that can give me a 5% yield year-in-year-out. I want to build an investment holding of $ 1,000,000 in time to come.

If I can accumulate to that amount, i would get a $50,000 passive income a year or $4000 a month – which is pretty good already in my view πŸ™‚

Hope you find this post useful to consider other investments types beyond just property, fixed deposits and stocks.

As always, your comments are welcome.

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2 thoughts on “Corporate Bonds, Preference Shares, Reits – How to decide?

  1. Hi Warriortan ,
    Thanks for the great summary n comparison of theses 3 types of low to moderate risk types of investment ,,,which is suitable for low risk appetite retail investors or retiree as part of diversification in their portfolio..
    Just to add that ,,for preference share ,,, although is perpetual but callable ,,, one need to take note on the possible callable date and not buying at high premium,,, e.g.. OCBC 5.1 % NCPS ,,,, is callable on 28 Sep 2018 and if the bank really redeem the share at par ,,, yield may not be 5.1 % at current premium price… also if is not being called ,,, the rate will drop to 2.5% +SOR there after,,, total yield may drop to around 3.5 % since SOR is around 1% now,, hope investors who wanted to buy preference share would take note about such feature,,,
    Cheers!

    Like

    1. Hi STE, that is a great point. Indeed, one needs to study the details before plunging head first into any investment. Great reminder from you!
      By the way, I like your blog too and I am reading ε†·ηœΌ now as recommended by you. Let’s stay connected.
      Cheers!

      Like

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