As beginners learning how and where to invest money in Singapore, we tend to have a unique interest in investment products that offer high dividend yield. This is the reason why many had invested in Reits such as Capitaland Commercial Trust, an associate of Capitaland and Mapletree Logistic Trust, an associate of Mapletree Investments. However, there are other high yielding instruments such as perpetual. While perpetual bonds are higher-yielding, they come with a different set of risks. This was evident as Ascott Reit decided not to call their perpetual back last week. This was significant as it is the first time a Singapore Corporate has decided not to exercise the option on the first call date.
What are perpetual bonds
Perpetual bonds are a type of hybrid instrument. The reason they are considered ‘hybrid’ is that they have fixed income as well as equity properties at the same time. Like fixed income, perpetual have a fixed coupon that is normally paid on a semi-annual basis. Like Equities, they can be the written down and the investor can lose his or her principle when they invest in perpetual. This additional ‘equity’ like risk plus the fact that perpetual are bonds in perpetuity and thus do not have a maturity date are reasons why investors enjoy high dividend yield when they invest in perpetual.
Why will companies issuer perpetual bonds if they are more expensive
Some of us may question why a company will issue perpetual bonds especially if they tend to be more expensive than regular bonds. Companies tend to do this so that they can keep their debt levels low. The reason is perpetual bonds are often not considered as debt and are often found in the equity segment of the balance sheet.
Companies may need to keep their debt levels low as there may be rules set by regulators or rating agencies about the level of debt that can be accepted. For example, the monetary authority of Singapore has a rule that debt to asset ratio cannot be more than 45%. While this has been recently revised higher to 50%, companies are still restricted by these rules and thus perpetual issuance can be a way for them to work around these restrictions.
Risk 1: Writedown
One of the more obvious risks of investing in a Perpetual is the risk of a writedown. If the company is struggling financially, it is not obligated to return your initial capital to you. This is because not repaying the principle on a perpetual note does not mean that the issuer has defaulted. In some cases, issuers may restructure and allow perpetual debt holders to exchange their notes for equity stakes. However, this is often done at huge write-downs
Risk 2: Coupon Deferral
Another key risk when buying a perpetual is that you may not get your coupon payment if the company chooses to defer it. This is different from a regular fixed income instrument where failure to pay a coupon can be considered as an event of default. While the issuer is often not incentivised to defer the coupon payment as it often means they cannot pay out dividends to their equity holders as well, the investor still bears the risk.
Risk 3: Call Risk
Even if the issuer does not write down the perpetual or stop paying the coupon, there is also a risk that the company will not exercise the call. As perpetuals are fixed income instruments that have no maturity, companies often put in place various call dates out into the future so that they can buy the bonds back from investors. As many investors price these bonds to the nearest call date, the sudden increase in duration means that the bonds will experience a significant drop in price and market value.
We know that perpetual bonds are exciting as they are high yielding and can result in strong investment returns. However, it is important to know the risk that the return is compensating the investor for. Hope everyone benefits from knowing a little more about this particular kind of fixed income instrument.