Malaysian capital market consist of various investment vehicles. There are in the form of shares, unit trusts, bonds, warrants and derivatives. Type of investment vehicles for an investor to choose from to invest in is usually determined by several common factors:
- Investment goals
- Risk appetite
- Risk tolerance
- Period
- Capital
Bond or Sukuk
A bond is normally a long term debt securities offered by companies or governments to investors for them to finance their capital expenditures. On the other hand, the bond that is issued in compliance with Shariah principles is known as Sukuk.
Without a doubt, whenever an investor buys a bond, they will become bond holders. They are entitled to receive:
- Periodic coupon or return on the principal amount raised by the issuer and
- Upon maturity, the principal amount will be returned to the bond holder.
In layman’s terms, we are acting like an ‘Ah Long’ who is giving a credit to the company and expecting them to pay us an interest or dividend on yearly basis. By the end of the period, you’ll get the principal.
Investing in Bond or Bond Fund?
Prior to 2018, the bond market was inaccessible for retail investors in Malaysia to do their trading. It required high cost of initial investment with the minimum amount of RM 250,000.
Therefore, many retail investors resorted to affordable bond funds as an alternative to investing in these asset classes. However, bond funds have a different mechanism from individual bonds in terms of the maturity date, principal return, income payment, and other characteristics.
Due to these differences, it is important to be able to distinguish between bond funds and individual bonds before you decide which one to opt in. Bond fund normally available within any Unit Trust Management Company
What is Bond Fund?
Bond fund is a mutual fund. It only invests in the bond asset class. Bond funds are typically sold by asset management institutions. Whenever you are investing in a bond fund, the money deposited will be pooled together with the money from other investors.
This pool of money then will be used to buy hundreds of bonds from different issuers with various yields and maturities. This is why bond funds are preferred by some bond investors as it offers diversification at a low cost compared to buying individual bonds.
A professional fund manager will be assigned to manage the bond fund portfolio and decide which bonds to trade. Hence, investors only put their money in the fund and leave the investment decisions to the fund manager.
One thing to note about the bond fund is, investors do not actually own the bonds. Instead, they own shares or units of the bond funds. Once investors put their money inside the bond fund, they actually buy the shares or units. The price of shares or units is subjected to Net Asset Value, NAV. The bond fund will calculate the NAV at the end of the day which determines the value of the bond fund. This means investors are open to fluctuation in bond fund values.
What is Individual Bond?
Individual bond is a bond that investors buy from particular issuers in the secondary market through intermediaries such as banks. Unlike bond funds, investors need to have a lot of investment capital in order to buy individual bonds.
Typically, one lot of bond is sold for RM 5 million, while odd lots are sold for a minimum of RM 250,000. Imagine how much money investors need to prepare if they want to buy many lots of bonds just to buy their bond portfolios.
This is the reason why bonds are only invested by high net worth individuals and institutional investors such as banks, asset management and insurance companies.
Investors who invest in individual bonds own the bonds itself. Further to that, issuers have contracted liabilities to bondholders according to the bond covenant and the investment capitals are guaranteed by the issuers.
Differences between Bond and Bond Fund
| Characteristic | Bond Funds | Individual Bond |
|---|---|---|
| Maturity | Do not have maturity date as bonds are constantly bought and sold off | Has maturity date |
| Income Payment | Fluctuate income distribution | Fixed interest rate paid annually or semi annually |
| Principal Protection | Need to sell units to recover capital. The value will be depending on market value. | Initial investment is guaranteed by the issuers and will be returned at maturity |
Source
- The Economist Guide to Financial Markets
- Investing in Bond Funds or Individual Bonds?