In this low interest rate environment due to COVID-19 externalities, it has been a tough year for investors. In the attempt to maintain the desired returns, investors are being forced to venture into riskier assets. This is on top of the economic hardships that may be experienced by individuals. In other words, on top of being worried on retrenchment, people may be worried as well on how to achieve Financial Independence, Retire Early.
For the typical individual, that would mean the need to explore ploughing money into riskier assets such as equities, credit-related funds, alternative assets (e.g. real estate), or even hedge funds (for sophisticated investors), given ‘perceived’ safe fixed deposit may be too meager. Henceforth, knowledge of financial products alongside the relevant risk-exposure would be more vital than ever.
Before I proceed further, let me emphasise that this is not an investment advice and please seek an appropriate, certified advisor for guidance on investment. This is posted up out of interest and bear in mind, all investments may entail loss in principal due to the need to undertake risks to generate return.
A Brief Look At Bond Fund
To recap, a bond works as an IOU and its pricing relates to time value of money. As with most credit-related instruments, given the lack of equity participation, investors forego the potential growth of the underlying issuer in exchange for perceived stability and preference in cash flow waterfall, assuming issuer defaults. Such stability of coupon payments (assuming sound credit risk), makes it an attractive instruments for investors that rely on cash in flows.
I had the privilege to take a glance at Public Enterprises Bond Fund, a bond fund by Public Mutual, a private unit trust management company in Malaysia (wholly-owned by Public Bank). This is a mutual fund that invests in the fixed income (minimum 75%), with remainder in money market instruments. Of total portfolio exposure, up to 30% of the fund’s NAV would be in foreign assets, namely USA, Australia, Singapore, HK, and Indonesia. Aside from understanding the country exposures (which would relate to the country’s credit, FX, obligor credit risk, and interest rate risk), one would need to be mindful of the following as well:
- Trustee fee
- Management fee
- Sales charge
- Switching fee
- Distribution policy
Therefore, before looking at the fund’s performance, we should zoom into the following key risks and fees:
- Country credit risk: USA (Developed Market), Australia (Developed Market), Singapore (Developed Market), HK (Developed Market), and Indonesia (Emerging Market), Malaysia (Emerging Market - not applicable as this is home country)
- Obligor credit risk: Financial institutions and corporates
- FX risk: USDMYR, AUDMYR, SGDMYR, HKDMYR, MYRIDR - appreciation of foreign currency against MYR (prior to investing)
- Interest rate risk (low interest rate means high bond price) - view from country’s monetary policy):
Fees or Related
- Trustee Fee: 0.035% p.a. of NAV
- Management Fee: 0.75% p.a. of NAV
- Sales Charge: 1% of NAV per unit
- Switching Fee: Minimum up to 0.25%
- Distribution Policy: Once a year (note for typical bond, distribution is twice per year)
- Benchmark: 12-month fixed deposit rate by Public Bank Berhad
Now with these identified, time to move forward to high-level, qualitative exercise:
- Country credit risk: Developed markets would generally, have lower perceived credit risk as compared to emerging market as creditors would trust their financial capabilities to repay their dues. Therefore, credit risk premium would be lower compared to emerging market - limited to 30% of NAV
- Obligor credit risk: This is very subjective as it depends on the credit-worthiness of the bond issuer itself; best to approach it on a case-by-case basis
- FX risk: For the listed currencies and assuming if the fund manager is still investing out, if foreign currencies strengthen against MYR, it would be adversely impact the fund (and ultimately, the unit holders themselves) - limited to 30% of NAV
- Interest rate risk: With current interest rate environment being so low and assuming central banks for listed developed countries would floor their policy rate at zero, in fixed income market, it is akin to buying at one of the highest price point (specifically towards new debt issuances)
- Benchmark: Comparing a fixed income and money market instruments, net of fees against a 12-month fixed deposit rate which is controlled by parent entity; may not be the most appropriate benchmark
Moving on, it would be appropriate to deep-dive into the individual securities and obtain a high-level of the securities that are being held. Below is the list of top 5 bonds held (as at 31-Mar-2020; with either maturity or next call date):
- Malayan Banking Berhad 4.13% Perpetual, Callable 25-Sep-2026 - 12.24%
- Sabah Development Bank Berhad 5.50% 24-Apr-2026 - 9.81%
- Bank Islam Malaysia Berhad 3.75%, Callable 26-Mar-2025 - 6.77%
- Affin Islamic Bank Berhad 5.05%, Callable 23-Oct-2023 - 6.01%
- Public Bank Berhad 3.90% Callable 29-Jul-2024 - 5.69%
Based on the remaining tenor and the last traded yield as at 25-Nov-2020, the weighted average remaining tenor of top 5 holdings is 4.75 years, with a yield of circa 3.54% p.a. It is good that Bank Negara Malaysia published FAST in order to quickly look up yields of bonds, including benchmarks. Hence, as at 24-Nov-2020, the indicative MGS yield is indicatively 2.094% p.a., taking an interpolation between 4Y and 5Y via 4.75Y, as published.
Based on the above, the top 5 holdings of the bond portfolio is circa, MGS + 1.45% p.a. (2.094% + 1.45%). Now, subtracting only management fee and trustee fee, as investors, we would land at MGS + 0.665% p.a. (1.45% - 0.75% - 0.035%).
Interestingly, BNM FAST published a consolidated view on corporate bond ratings based on tenor and the relevant rating assigned per relevant financial institution submission, just for reference. Using Maybank that is rated A- by S&P500, the reference page indicated that the yield should be circa 5.15%. Using the MGS level of 5Y of 2.113%, that would mean the spread would be circa MGS + 3.037%. This shows a whopping difference of 2.372% p.a. of credit spread, assuming investors decide to buy into the Public Enterprises Bond Fund.
Factoring the previous points shared above, I will leave the judgement call to yourself whether it makes sense to invest in this or otherwise.
Moving On To Equity Fund Next Time
I looked through Public Healthcare-Global Equity Fund. This mutual fund is basically an equity fund that invests in equity and equity related securities, globally, with 30% of the fund would be in healthcare related stocks and collective investment schemes (think of it like fund in a fund). I will describe further in my next blog posting.