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Making brave (or foolhardy?) bets in an insipid market

Bonds that are trading below par offer attractive dividends but investors should also heed the fear factor

As we enter the last quarter of the year, I have to admit my investment activity so far has been rather insipid. On the stock market, I have bought little and sold even less

As a result, my most profitable trade is also embarrassingly staid.

At the start of the year, I picked up some shares of Neptune Orient Lines (NOL). This was after the French-based CMA CGM had unveiled a takeover offer for the Singapore container shipping company.

A case of shutting the barn door after the horse has bolted? Not quite.

After CMA announced a conditional offer of $1.30 apiece last December, NOL shares persistently traded at around the $1.23 level for quite some time.


ST ILLUSTRATION: CHNG CHOON HIONG

Although this was a serious offer with proper financial backing and an irrevocable undertaking by controlling shareholder Temasek Holdings to accept the deal, the market discount to the offer price reflected some uncertainty as there were some regulatory hurdles to cross before the buyout could be completed.

The discount also took into account the time value of money as CMA CGM had up to a year to table a firm offer. Simply put, money in the bag is worth more today than a year later.

When Olam International was forced into a rights issue in late 2012 to raise funds to shore up its capital following a sustained attack by United States-based short seller Muddy Waters, I bought the beaten down stock enthusiastically. That was because the rights issue gave shareholders the right to subscribe for bonds on very generous terms, with free warrants thrown in to boot.

This notwithstanding, I calculated that a seven-cent gain over one year translates into a yield of 5 per cent for what amounted to very low risk.

In the end, the deal was completed ahead of time. I held the shares for only about six months, which works out to a yield-to-maturity of about 10 per cent. Unfortunately, there has not been an opportunity to earn a similarly low-risk return since I got back my money in June.

The performance of blue-chip stocks has been rather uninspiring this year.

The SPDR Straits Times Index exchange-traded fund shows a return of only 0.51 per cent, inclusive of dividends, for the six months to June 30. Over a one-year period till end-June, the fund's return was negative 11.4 per cent. So I am quite happy to have avoided putting money on big-name stocks this year.

Instead, I invested a small sum in second-liners. Not in their shares, mind you, but the bonds that were made available to retail investors.

I like plain vanilla bonds for their simplicity.

Aside from lower risk - since bond holders are ranked above shareholders in the event of a winding-up of the company - there is also less variable investing in bonds compared to equities. As long as the issuer doesn't go bust, bond holders will collect regular coupon payments or interest and get back their principal sum in full upon bond maturity. A shareholder, on the other hand, must deal with market vagaries that will affect the value of his principal at the point when he exits the investment.

Ordinarily, bond investments tend to offer unexciting returns due to their lower risk.

However, the current environment has not been kind to bond investors.

Holders of Swiber Holdings, Perisai Petroleum Teknologi and Rickmers Maritime Trust bonds have seen their investments decimated, no thanks to a blowout in the oil and gas industry. Consequently, the bonds of all highly geared companies - even those that have nothing to do with oil and gas - have come under pressure as investors take a better-safe-than-sorry approach.

For instance, bonds issued by Oxley Holdings and Aspial Corp as well as the perpetual securities of Hyflux - which were popular with retail investors - are trading well below their par value after Swiber's woes surfaced as investors began to fret over the companies' stretched balance sheet, falling earnings, high gearing, poor interest cover and persistent negative cash flows.

As the bond prices fall, their yields (coupon payment over market price) have risen. For instance, Aspial's 5.3 per cent bond maturing on April 1, 2020 has a yield-to-maturity of nearly 8 per cent.

I'm a faithful follower of famed investor Warren Buffett's investment adage: Be fearful when others are greedy and greedy when others are fearful.

There is no doubt that fear is driving up the yields on these bonds.

Unjustifiably so, in my opinion, which is why I have added a modest amount of some of these high-yield retail bonds to my portfolio.

When Olam International was forced into a rights issue in late 2012 to raise funds to shore up its capital following a sustained attack by United States-based short seller Muddy Waters, I bought the beaten down stock enthusiastically. That was because the rights issue gave shareholders the right to subscribe for bonds on very generous terms, with free warrants thrown in to boot.

Fundamentally, I believed that Olam could ride out the storm, particularly with the strong backing of its major shareholder Temasek Holdings.

Despite Temasek's commitment to take up any bonds and warrants that remained unsubscribed, there were plenty of expert naysayers who continued to fan fears about Olam. Some minority shareholders must have given in to those fears. As a result, Temasek's stake in Olam rose to 24.6 per cent, from 16.3 per cent, by the end of the offer. Some shareholders did not take up their entitlement, leaving behind some 1.57 million bonds.

Not me.

Not only did I take up my allotment in full, I also bought the nil-paid rights in the market so I could subscribe for even more of the bonds, which had a tantalising yield of 8 per cent. Incidentally, it was then that I found out that the rules do not permit me to buy nil-paid rights under the Supplementary Retirement Scheme (SRS).

However, if I already have the underlying shares in my SRS account, I am allowed to use the funds to subscribe for the bonds. Which I did. I ended up having Olam bonds in both my Central Depository and SRS accounts.

The investment paid off handsomely. But it was too good to last. Having ridden out the Muddy Waters storm, Olam redeemed these "expensive" bonds three years ahead of maturity.

Likewise, I am convinced that the real estate-related issuers behind the retail bonds can stay solvent, based on the strength of the markets in which they operate and the fact that their projects are substantially sold, although it is worth noting that the sharp fall in the pound as a result of the Brexit vote will probably have bruised Oxley, which has a significant exposure in UK real estate.

Just to be clear, I am not making a stock or bond recommendation to readers but rather sharing the thought process that goes into my investment decisions.

Am I being smart buying these bonds that are trading below par or foolish in throwing good money after bad? The jury is still out.

A version of this article appeared in the print edition of The Sunday Times on October 09, 2016, with the headline 'Making brave (or foolhardy?) bets in an insipid market'. Print Edition | Subscribe