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CapitaMall Trust: Buy the retail bond or the REIT?

Monday, February 10, 2014

CapitaMall Trust is offering $200 million worth of bonds. They will mature 7 years later in 2021 and will have a coupon of 3.08%. Is this a good thing?

Well, as the REIT has quite a bit of debt due for repayment this year, this fund raising effort is necessary and timely. The coupon of 3.08% is also lower than their average cost of debt of 3.4% as at 31 Dec 2013. So, this is a good thing for unit holders of the REIT. DPU won't be negatively affected.


As S$150 million of the retail bonds will be offered to the public with the minimum investment sum set at only $2,000, it is within reach of regular retail investors like you and me. If we look at this as a kind of forced savings, a pseudo-CPF if you will, and hold it for the full 7 years period, I think it is not that bad a proposition. Why?

Well, if we hold it for the full 7 years, we won't suffer any capital loss which could happen if we decide to sell before maturity.

You mean we might lose money if we cannot hold for the full 7 years? Yes, possibly, especially with expectations that interest rates will continue rising.

So, if the risk free rate should rise by 1%, investors might expect a 4.08% return from this instead of the 3.08% being offered now, for example. The bond price would have to fall in order to offer this higher return. How much must the bond price fall to give this return? Approximately 25%.

Pause.

Pause.

Pause.

Yes, 25%. The good news is that if we were to hold to maturity, then, we are safe. So, what to do? We buy the bond with money we don't need for the next 7 years. We will get back our principal when the 7 years is up, well, if CMT doesn't go belly up. (See comments by Charlie and AK71 in the comments section below.)

So, this retail bond offering could benefit anyone investing for income in two ways. Invest in the REIT for a distribution yield of 5.64% (unit price of $1.815 at closing) or to buy the bond for a coupon of 3.08% over the next 7 years.

Wah! AK71 so silly. Of course, invest in the REIT. The yield is so much higher! Well, remember that REITs are leveraged investments. Without the gearing of about 35%, the distribution yield wouldn't be so much higher and would be closer to 3.75%. Gearing is a fantastic thing, isn't it?

Wait a minute, 3.75% is still higher than 3.08%. So, investing in the REIT is still a better choice. Indeed, it seems to be the case and that would be my preference too.

Remember that this analysis has taken place in a vacuum, totally ignoring other factors which could have a bearing on the performance of the REIT or the retail bond. However, comparing the two options thus gives us a clearer picture of which option an investor for income might want to lean towards.

Read: CapitaMall Trust launches retail bond offering.

Related post:
Saizen REIT: Risk free rate and unit price.

20 comments:

Tien Song Chuan said...

I was wondering why the REIT needs to borrow money from the public. Is it because they want to pay lower interest as compared to the banks now, or is it that they expect the bank will charge an increasing interest in the next seven years, so they need some secure, low and lock-on rate for the money?

AK71 said...

Hi Tien,

Well, for the exact reasons why, we will have to ask the REIT manager. ;)

However, it is definitely prudent to diversify its sources of funding which some other REITs have done as well but with higher costs. So, the fact that CMT could do this and attract a lower cost of debt at the same time is a big positive. :)

CharlieK said...

Hi AK,

How did you calculate the price drop of 25%? This bond has a term of 7 years and since it's paying coupons, the bond duration is probably between 6-7 so a 1% change in interest should only have a 6-7% impact on price and the impact should diminish as the bond duration decreases as time passes. It seems a 25% drop would only happen if the risk free rates suddenly rises by 4% (I.e. investors expecting 7.08% instead of 3.08%)!

ThinkOutOfTheBox said...

Instituitional investors are not attracted to the 3.08% pa yield. There are tons of investments available to them with much more yield.

So raising this amount from the retail public is more viable.

Also, remember the news last year about offering more bond issuance to retail investors because of some feedback....here it is.

Kills 2 birds with 1 stone

Tien Song Chuan said...

Well, whether you are buying bonds or units, it sure beats buying Toto and 4D.

Tien Song Chuan said...

There is a computer game : Cashflow that teaches you how to get rich. You can play it online using virtual money.
http://www.richdad.com/classic

AK71 said...

Hi Charlie,

If risk free rate were to rise, then, the price of the bond will have to fall enough to match the increase.

So, if a bond that was yielding 3% a year now needs to yield 4% instead on a yearly basis in order for it to be attractive to investors, a 25% fall in the bond price is what is required.

In other words, if I were getting $3 for every $100 before and now I need $4 instead, I would only be able to get $4 if I pay not $100 but $75 for the bond.

However, you are absolutely right that my calculation is not accurate because the bond matures in 7 years!

I guess my calculations would be more accurate for longer term bonds (30 years) or perpetual bonds.

My calculation is inaccurate because buying this bond at $75 instead of $100 in the 6th year for example would return more than 30% upon maturity, far outstripping the 4.08% that I hypothetically put forth.

Thanks for the nudge. :)

AK71 said...

Hi TOOTB,

So, you think the government might have a hand in this? Hmmmmm.....

AK71 said...

Hi Tien,

I indulge in TOTO and 4D from time to time. -.-"

Hope I am lucky in the $10 million TOTO this Friday. ;p

veronika said...

In a way, the MAS or our Government in general is perhaps trying to educate the general public about bonds... by making it accessible in lots smaller than $250K ( which is the smallest generally in bond market )
It is slightly better than the 2.5% CPF ordinary account. But it allows access to the money and so provides an alternative risk management.

Thanks AK for trying to make this topic as simple. There are many people out there who are not able to do simple comparative analysis... they are unaware of the information and how to gather them.

For the conservatives, bonds is one way of investing for income. At the moment the returns are higher than a fixed deposit, and that is where much of the conservatives' money is parked.

Holding Bonds till maturity is something many people are confused because there is a ton of articles and news about bond yields. None talk about holding till maturity.

So these folks are fearfull, reading about yields dropping etc... business mags and news focus on the big boys buying & selling of bonds.

Inflation?.. 7 years is not too bad.. we think inflation can only go up... it can come down too. That is another fear mongering by finance gurus/writers... If we focus on income generation, earnings.. the effects of inflation can be kept at bay... anyway.. there is always a cost to everything.. just minimise the cost.

A skill that you have mastered!

Tien Song Chuan said...

You will not win the Toto. Want to bet?

Tien Song Chuan said...

It will better to buy the Toto company shares.

AK71 said...

Hi Veronika,

Thank you for the encouraging comment. I am glad that you feel my blog post is easily understood probably by anyone out there who might be interested in the retail bond. :)

There is a lot of noise everywhere we go but I am also contributing to the noise and I can only hope that my noise is a bit more intelligible than the rest. ;p

AK71 said...

Hi Tien,

I will place a bet for a chance to win $10 million but I will not place a bet on definitely winning it. There is a difference, you know? LOL.

Can we become shareholders of Singapore Pools'?

Tien Song Chuan said...

Hi AK:
It is true that there is a probability that you can win Toto. But the chance is smaller than you being killed by lightning and car accident. This is one bet that you are sure to lose. Owning the toto company is the only sure way to win.
If you put the money for toto into a piggy bank, then at the end of a certain period, you would have a savings!

Tien Song Chuan said...

Futhermore, if Toto is so easy to win, the Toto company would have liquidated long ago.

AK71 said...

Hi Tien,

Lucky I am not a hard core gambler. Otherwise, I sure to be angry with you. Simi sure to lose etc. etc.? LOL.

Anyway, you might not believe me but I have made more than lost in gambling over the years because I don't gamble often and my bets are always small. I buy TOTO only on special occasions when the jackpot is substantial, for example. ;)

This reminds me of an old blog post:
Is gambling a bad thing?

Ben said...

I guess one reason for the lower yield on corporate bonds is that bondholders would have a preferential claim to the assets of the company in liquidation ahead of the shareholders.

AK71 said...

Hi Ben,

Considering that the bonds they issued in 2012 had a coupon of 3.8%, iirc, I find it hard to explain it away using that line of reasoning. Oh, well. I guess this is another one for the academics. :)

AK71 said...

"...the yield on a fresh 7 year A rated corp bond might rise above 3% as early as 2016, when there are 5 years left before CMR's bond period is up. Those who lock up too much money in the CMT bond will miss out on a lot of potential gain."

BT, 13 Feb, Page 6.

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