In managing our money, many of us fail to heed a piece of common sense advice: "If it sounds too good to be true, it probably is."
This well-worn adage crossed my mind as I read a recent Reuters article headlined "Singapore's aunties and uncles take risks in hunt for yields".
The article raised questions as to whether not-so-financially-savvy investors here understood the risks they were taking in subscribing to heavily indebted jewellery-to-property group Aspial Corporation's retail bond offering.
The response to that bond offering had been so overwhelming that it enabled the company to upsize the public tranche reserved for retail investors dramatically - from $50 million to $175 million.
Sure, the 5.3 per cent yield offered by Aspial was well above the returns available on savings accounts. But the yield was not so high as to put investors on their guard since it was not significantly higher than the market as a whole.
The fact that the bonds would mature after only four years was another attraction. This is a short enough time span retail investors can live with as they wait to get their money back while enjoying the juicy returns offered.
The Reuters article asks a salient question: How many retail investors really studied the company's financials before hitting the ATMs to apply for the bonds?
Now consider Catalist-listed Apple product reseller EpiCentre: The company set tongues wagging following a report that it had ventured into the crowdfunding space recently to offer an eye-popping yield of 13.5 per cent in trying to raise up to $2 million to be repaid within 12 months.
Considering that there are many ways a listed company can raise money, it is perhaps a tad surprising that it should have to resort to such a drastic measure to borrow a small sum.
As one blogger observed, for EpiCentre to even consider raising money at this price, there must be a compelling reason. "Could they have exhausted other sources of financing? Do they really need cash that urgently?" he asked.
For me, the fact that retail investors reacted so differently to the fund-raising exercises by Aspial and EpiCentre is a reflection of their perception on investment risks - that is, the higher the returns, the higher the risks.
While that may be generally true, my question to retail investors is whether they may be too sanguine in applying such a test to all their investment decisions.
Sure, all investors, including myself, would like to enjoy a return which is higher than the paltry payout offered by bank deposits or Singapore Savings Bonds. But we are also wary of the risks we may have to shoulder in achieving it.
As a result, we become suspicious of any investments that offer a yield markedly higher than the rest of the market. We reason that there must be a hidden risk somewhere to account for the higher yield.
But my big concern is to underscore the point that just because a bond yield is priced around the market norm, that does not, in and of itself, make the investment "safe".
I believe an investor still has to do his homework to assess the risks involved before he buys the bond - even more so, if the bond has not been rated by a reputable credit ratings agency, as is the case for many of the newly issued bonds.
At a seminar last year, Mr Andrew Fastow, the former finance chief of failed energy giant Enron, demonstrated how investors could be lulled into a false sense of security by their "safety in numbers" logic.
When he asked for a show of hands from the audience if they thought an investment offering a 10 per cent yield would be risky, he got a response of almost 100 per cent. Then, as he slowly brought the yield level down towards 5 per cent, the number of hands going up started to drop dramatically.
But do lower returns automatically translate into lower risks? Not necessarily.
Take the ill-fated Lehman Brothers-linked minibonds, the toxic structured product which maimed about 9,900 people who lost most or all of their $520 million worth of investments when the bonds turned sour after the US investment bank collapsed eight years ago.
When Lehman first ventured into Singapore in 2006 to sell the toxic product, it touted it as an opportunity for investors to invest in new "bonds" made up of other bonds such as DBS Bank, Singtel, American Express, Citigroup and JPMorgan Chase.
The 5 ½ year note offered retail investors an annual coupon payout of 5.5 per cent if they invested at least US$5,000 in it. That was not exactly the type of yield which would put a newbie investor on his guard, especially when it was sold by a triple-A rated financial institution.
Little did the investors realise that what they were being offered was a bunch of IOUs by Lehman backed by collateral made up of a complex financial derivative product known as collateralised debt obligations.
In the aftermath of the debacle, one question I got from angry investors was why a "bond" which offered a mere 5.5 per cent yield could suddenly become worthless. What upset them even more was that they had believed they were not taking extraordinary risks because the returns were not sharply higher than the market average.
So what should an investor do in assessing the risks before making a bond investment? Some analysts would suggest using complicated formulas such as "net debt-to-Ebitda" and "interest coverage ratio" to try and gauge the risks involved.
But to the "auntie and uncle" investors, this would sound like so much mumbo jumbo, even if they could half understand what the analysts were trying to tell them.
Instead, I would suggest asking a few simple questions before buying the bonds.
First and foremost, ask what is the likelihood of getting your principal back. This is because, unlike buying a company's shares in which an investor will be participating in the future growth of the business, in buying a bond, he is making a loan to the company.
As the Lehman example clearly shows, there is no point in collecting a few coupon payments only to see the principal going down the drain after the investment bank goes belly-up.
And do not imagine that just because a company is listed on the Singapore Exchange, that would make its bonds safe.
One example is the Hong Kong-based but SGX-listed Pacific Andes Resources Development, which defaulted on a $200 million three-year bond issue in January. Yet, when it sold the bonds two years ago, it had raked in an eye-popping $2 billion in subscription monies.
Another question to ask is how much money the company owes the banks and bondholders.
Most companies would undoubtedly hope to refinance their existing debts with fresh issues of bonds as they mature, but whether they succeed or not will depend on market conditions.
Financial crises now occur with such distressing regularity that there is no guarantee a company may not be caught in the middle of one just when it needs to do a refinancing exercise.
And a heavily indebted company is a lot riskier than a less-indebted one when market conditions turn turbulent.
As the global financial crisis has shown, all it takes is for a jittery bank to pull the plug on the credit line to precipitate a stampede for the exit by other lenders. That may turn into a life-and-death struggle for a company as it tries to find other life-sustaining credit lines even though its businesses may still be doing fine.
Above all, check for conditions which may cripple the company's ability to service its debts.
Mr Fastow observed that a firm can follow all the rules and still slip into bankruptcy without defaulting on its debts when there is a massive market disruption.
One example he cited was the auto giant General Motors which had to rely on a US government bailout to stave off bankruptcy in 2009, after it was unable to issue new bonds or get banks to lend it fresh money. This was because while banks had stayed comfortable on the US$140 billion of debt on the company's books, they had become cagey about its US$100 billion unfunded pension liabilities, wondering if it could ever sell a sufficient number of vehicles to pay them off.
Mr Fastow said: "The banks had known all along about GM's pension liabilities but they simply changed the way they wanted to evaluate its creditworthiness. So overnight, they stopped lending GM money even though there was no change in information."
Fortunately for GM, the US government came to its rescue, but not every company will be as lucky.
That means a bond investor will have to look beyond the firm and examine the credit profile of its big shareholders carefully.
Ask yourself: What are they like? Would they have the capacity to recapitalise the company's finances if it is caught in a credit crunch, or will they walk away?
Make sure you go through this checklist before you touch a bond. If the questions cannot be answered satisfactorily, you will do well to walk away, no matter how attractive its yield might be.
Your money is, after all, yours to lose. Caveat emptor (buyers beware).
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