By Althea Spinozzi, Fixed Income Strategist at Saxo Bank.
Investing in bonds is a good way to diversify your investments while reducing risk exposure. Bonds are considered a safer asset when compared to stocks or currency trading. But if you’re just getting started, it can be quite tricky to understand what bonds are (and aren’t). They’re fundamentally different from stock trading and require a different approach.
So, what are bonds?
In technical terms, bonds are fixed-income instruments that governments and financial institutions sell to raise money. In layperson’s terms, bonds are loans that investors make to the issuing agency.
Bonds differ from stocks in that the income is fixed at the time of issuance, and there’s limited scope for loss. Just like when you take a loan from the bank and are obliged to pay it back, the issuing agency must pay you the amount back at the set expiry date.
There are multiple reasons why investors buy bonds. One is to diversify their portfolio. Amounts raised from bonds are invested in various projects, generating revenue for the agency. A part of the revenue is handed off to the bondholders. As an investor, if you have invested in the said project, you diversify your portfolio by buying bonds. Even if your initial investments result in a loss, you can recoup some profit through bonds. Remember, issuing agencies must pay back the amount, irrespective of whether the project succeeds or fails financially.
Bonds are safer than stocks because they are less volatile than stocks and often perform better during a recession. High-quality bonds, and safe havens, in particular, tend to gain amid a downturn.
Another reason why bonds are a sought-after investment asset is because of predictable income. When you buy shares, the profit depends on the stock price movement. Even in forex trading in the UAE, the price movement determines the profit. But bonds are a different game altogether. You’re almost guaranteed a certain amount even before you purchase the bond. The interest and principal amount are then paid over the tenure date.
Furthermore, you can trade bonds as you do with shares. You can sell bonds in the secondary market before expiry and redeem profit. The best online trading platform in UAE allows you to buy and sell bonds like you would forex currency or shares. So, there are multiple ways to profit from bond trading.
Types of Bonds in UAE
Before you start investing in bonds, keep in mind that there are different types of bonds. Generally, you’ll find three broad types of bonds to invest in government, corporate, and municipal. As evident by the nomenclature, government bonds are issued by the government, corporate bonds by corporations, and municipal bonds by local municipalities. These also differ by amount, interest, and tenure, among other things.
The UAE government issues T-bonds or Treasury Bonds to raise money to build the economy. Local and international investors can purchase T-bonds if they meet the terms and conditions. This year’s first auction of UAE treasury bonds was issued in January and was oversubscribed 6.2 times, meaning 6.2 times more people registered to buy the bonds than what was available. This shows the demand for bond investment in the UAE.
Bonds are not compliant with Islamic investing. For such traders, there’s something called T-Sukuk, which, more or less, acts like the T-bonds.
The UAE government also issues international bonds. But it’s intended for the international market to raise more funds.
As an investor, you should also consider corporate bonds. These are issued by the issuing companies. When investing, you should look at both credit and rate components. Their creditworthiness may fluctuate depending on the company’s performance. However, the rate component is linked to government bonds. So, investment-grade bonds tend to lose less of their value even during a market downturn. But take a cautious approach towards junk bonds which are most likely to lose their value in uncertain environments.
After a difficult 2022, 2023 is the right time to invest and diversify in bonds. The US Treasury is the highest it has been in more than 10 years. So it makes sense to invest in one of these instruments and high-grade corporate bonds to maximize returns.