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Will Savings Bonds really save the day?
Singapore plans to introduce Savings Bonds in the second half of 2015. Not every detail has been set, but what is already known has already gotten the product some praise from financial advisers.
Here are some of the key features:
- Coupon will step up every year to mimic the yield of a Singapore Government Security (SGS) that was bought at the start of the Savings Bond and that matures in the current year.
- May be redeemed for the full principal amount plus accrued interest at any time.
- Will have a maximum tenure of 10 years.
- May not be traded.
- Restricted to individual investors and subject to a participation cap that has yet to be determined.
At first glance, financial advisers and industry insiders have remarked that the Savings Bonds look more attractive than fixed deposits and many insurance endowment products. In particlar, the fact that the Savings Bonds may be redeemed at any time with a yield-matching mechanism and the potential to hold them for up to 10 years are features that investors value. Not to mention that the Savings Bonds enjoy the very robust guarantee of the Singapore government.
But the fundamental rule in investing is that higher returns come with higher risks, and therefore lower returns must come with lower risks. If the product looks great from a risk and optionality perspective, it probably comes with a cost in terms of returns. Where are those costs with Savings Bonds?
Opportunity cost sets the Savings Bond apart from a regular SGS. Assume that I buy $1,000 of Savings Bonds and $1,000 of the 10-year SGS at a time when the 10-year SGS yields 2.4 per cent and the 2-year SGS yields 1.2 per cent. After two years, I decide to cash out. Upon liquidating those positions, my Savings Bonds would have returned about 1.2 per cent. If inflation and interest rates expectations have not changed during those two years and I managed to sell my regular SGS position at par, I would have received a return of 2.4 per cent on my SGS positions. Of course, the price of the regular SGS could have gone the other way as well, a scenario that is actually probably given the likelihood of rising interest rates after 2015.
The yield on the Savings Bonds are also relatively low when viewed in the context of a broader spectrum of investment products. The strength of the Singapore government's credit is so solid, that one could presumably move out a little on the risk curve and perhaps buy some other AAA-rated corporate credit for a higher return and a small increase in risk.
Another cost to investors is that the yields are only matched in the current year of the Savings Bond. In other words, the Savings Bond's coupon is lower than the current year's yield for every year until the current year, in which the coupon is stepped up enough to make up the difference. This eats into the reinvestment gain that would have been made by buying a regular SGS.
There have also been some remarks that the Savings Bonds offer a way to beat inflation. That is wrong. There is no mechanism in the Savings Bond that adjusts for inflation. Like any other bond, the yield tends to reflect a premium to inflation expectations. The key word here is "expectations", which can be wrong. Investors who had bought bonds in 2012 or 2013, when both inflation expectations and interest rates were extremely low, would have found it hard to beat inflation based on market-determined yields in those years.
So do the Savings Bonds make sense for investors? The answer is, it depends on the investor's needs. If the investor's portfolio has a cash component that is constantly rolled into fixed deposits, the Savings Bond will offer a potentially longer-term solution that offers a nice combination of optionality and long-term returns. If the investor is looking for higher returns and does not expect short-term cash needs, there are products out there that could be better.