Download Bonds vs. Bond Funds - Personal Finance Advisers Philippines

Bonds vs. Bond Funds
Efren Ll. Cruz, RFP®
“Gentlemen prefer bonds.” – Andrew Mellon (1855-1937), American Financier
The more popular notion about investing in the markets in the Philippines involves
putting money in the stock market. In reality, however, investing is much more than
just stocks. Especially today, bond investing has never been easier and more attractive,
thanks to Comprehensive Tax Reform Package (CTRP) of 1997 and the operation of the
Philippine Dealing and Exchange System or PDEX.
Given the right market conditions, bond investing can be as profitable, if not more
profitable than stock market investing.
As mentioned in my book, “Pwede Na! The
Complete Pinoy Guide to Retirement and Estate Planning”, capital gains can also be had
with bond investing. In 2005, bond investors would have earned a return of 16% p.a.
just by trading in fixed rate treasury notes, more popularly known as FxTNs. During
this same period, the Philippines Stock Exchange composite index or PSEi produced a
slightly lower return of 15%. Investors who exchanged their US Dollars for Philippine
Pesos and traded FxTNs at that time would have made an additional 5% p.a. because of
the Peso’s appreciation. Of course bond prices can also move south and produce a low
or even negative return for the investor.
Provided bond issuers are able to weather economic slowdowns, their bonds will more
often than not outperform stocks during such economic downturns. Bonds are also
relatively safer compared to stocks as they not only have fixed coupons (although
some may have floating interest rates based on a certain benchmark), they also enjoy
priority over stocks when it comes to liquidation proceedings of the issuer.
For the Philippines, holding bonds till maturity or for at least five years is as attractive
as trading them. The CTRP exempted from the 20% final withholding tax on interest
income those individuals who would invest in bank issued fixed income securities with
a tenor of at least 5 years. This exemption also covered the fixed income securities of
non-banks provided that the tenor would be at least 5 years and that the investments
are housed in individual long-term accounts under Trust Departments of banks.
For its part, the PDEX made bond trading as easy as stock trading.
Nowadays, an
investor can just open an account with a PDEX-participant broker and trade away.
1
Government securities, with the exception of RoPs or the dollar denominated debt of
the Philippine government, are already actively traded on PDEX. And while the number
of PDEX-enrolled corporate bonds are still limited, these are sure to grow with the
busy schedule of fixed income offerings slated for this year and perhaps the years to
come. This year alone saw one primary offering after another with coupons ranging
from 7.5% p.a. to 10.5% p.a. and tenors from three to ten years.
Yet, the investor is faced with the same question with direct bond investing as with
direct stock investing. Can he really invest on his own? A simple guide to determine if
the investor is ready for direct investing is to ask if he is all SET. He should determine
whether he has the right “S” or size of funds so that he can demand lower broker’s
commissions and perhaps get some preferential treatment with the better deals (e.g.
like with getting allocations to primary fixed income offerings). More importantly, he
should determine whether he has the “E” or expertise to invest for himself. Learning
the inner workings of an investment is one thing. Understanding how different types
of investments behave with each other is another matter altogether. Plus, the investor
would need to study market psychology very closely, not so much as to go with the
flow, but to rise above the herd mentality. Lastly, the investor would have to assess if
he has the “T” or time to devote to investing. The more time he can devote, the less
mistakes he will make.
If the answer is a NO to anyone of the S, E or T, then the investor is better off buying
bond funds.
Bond funds, whether they are in the form of mutual funds, unit
investment trust funds or variable unit linked insurance would have the size of funds
through pooling of investors’ money, expertise with their full time fund management
team and time to invest to invest in bonds directly.
Remember the Pilipino song that goes “magtanim ay ‘di biro, maghapong nakayuko?”
(loosely translated, planting is no joke, all day you are bent over) Well bond investing
is the same thing.
There is a lot that goes on, from establishing risk return
parameters, to analyzing the individual characteristics of available bonds, to forming
optimal asset allocation strategies, to monitoring performance and rebalancing
portfolios. The investor would also have to be adept in both the portfolio and legal
implications of bonds. This is why having a team of experts, which is what bond funds
have, is always better than just the DIY (doing it yourself) strategy. Bond funds also
have easy and even real-time access to bond prices for best execution and portfolio
valuation. Bond funds even have their own fund accounting team so that the investor
just needs to lean back and relax while the bond funds do all the work.
2
But please note that bond funds do come at a price, the price of management fees,
sales fees and redemption charges (if any).
Moreover, since bond funds are not
classified as individuals, even though these are owned by individuals, they will not
qualify for the tax exemption on interest income provided by the CTRP.
Still, the
expertise and steady hand of a fund manager may make the big difference especially in
periods of unusual market movements like the recent global financial crisis spawned
by sub-prime mortgages.
So, which is better, direct bond investing or indirect investing through bond funds?
The investor should go through the SET rule and see for himself what is best for him.
Whatever the decision, it is best to be reminded of this quote from Warren Buffet, “It's
not whether you're right or wrong that's important, but how much money you make
when you're right and how much you lose when you're wrong.”
Happy investing!!!
Efren Ll. Cruz is a registered financial planner with the RFPI USA. He is author of the bestselling books, “Pwede Na! The
Complete Pinoy Guide to Personal Finance” and a “Personal Finance Coach.” He is Chairman and CEO of Personal
Finance Advisers Philippines Corporation. Questions about the article may be emailed to [email protected]. Efren
may be reached at the same email address for the scheduling of consultations and personal finance seminars. This
article does not constitute nor forms part of any offer or solicitation of an offer to buy or sell any securities. The
opinion and views expressed herein are solely those of the author’s and do not necessarily reflect those of the Personal
Finance Advisers Philippines Corporation.
3