Given the low interest rate environment now, there are many people looking for alternative of fixed deposit. The most commonly mentioned alternative are money market fund and bond fund. In fact even before drastic drop of interest rate in 2020, there were already many who had used bond fund to replace fixed deposit, and successfully received better return than fixed deposit. In case you do not know what a bond or bond fund is, this article could be a good reading material for you.
Table of Contents
What is bond?
Bond is a type of debt security. The issuers are normally governments or corporates for fund raising purpose.
Bonds are often categorized as fixed income securities. This is because under bond agreement, borrower (bond issuer) has to pay interest to lender (investor) at fixed interval until maturity date. Traditionally bond is issued based on fixed interest rate, but bond with floating interest rate are also available nowadays.
Why investing in bonds?
Here are advantages investing in bonds.
- Predictable return – The return of a bond (interest + face value) is fixed at the time of issuance.
- Recurring income – The interest of bond is paying on a regular basis (e.g. twice a year)
- Liquidity – Bonds can be traded among investors. Some bonds are publicly traded and some are only privately traded.
- Less risk – Because issuer has to pay accordingly to the agreement, otherwise it would result in default.
Bond vs bond fund
Bond fund is portfolio of a basket of bonds managed by fund houses. For retail investors, here are the reasons to invest in bond fund instead of directly in bonds
- Lower investment threshold – Bonds typically have very higher initial investment requirement. In comparison, minimum investment for bond fund can be as low as RM1000
- Diversified portfolio – Due to the fund nature of holding a variety of bonds, investing in bond fund provides risk diversification that is hard to achieve by investing in individual bond.
- Professional management – By leaving the investment decision to fund manager, you do not need to worry about how to select evaluate return versus risk of a particular bond.
Bond basics
Face value = Amount that bond issuer will pay at maturity
Coupon rate = Interest paid by bond issuer every year, it is expressed as a percentage of face value
Maturity date = Date which bondholder will receive face value of a bond
Credit rating = Bonds are rated based on issuer’s probability of default by credit rating agencies such as RAM in Malaysia and other international agencies (Standard and Poor’s, Moody’s, Fitch Ratings). Higher rating would enable government/corporates to issue fund with lower coupon rate, i.e. lower borrowing cost. In case of bond fund, usually it is disclosed in product sheet what is the minimum rating of fund they would invest in.
Above are just some basic knowledge of bond. For bond fund investment, I think understanding of the above would suffice but learning more does not harm.
Charges and costs for bond fund investing
Here are charges and costs associated with bond fund.
- Sales charge = Charge that needs to be paid upfront when buying bond fund. Some bond funds come with zero sales charge.
- Platform fee = Instead of sales charge, there could be platform fee charged by certain platform. It is charged on regular basis (e.g. quarterly). Platform fee is deducted from fund holding, fund holder do not need to pay separately.
- Redemption fee = Charge that needs to be paid when selling bond fund. Not all funds come with redemption fee.
- Expense ratio = (management fee + trustee fee) / fund price. It is expressed as a percentage of net asset value of fund.
Typically to select a bond fund, investor will look at their historical return. Note that the return showed is after deduction of management fee and trustee fee. The additional costs shall be considered are sales charge, platform fee and redemption fee.
Risk of bond fund
While bond fund is considered as low risk investment, it still poses higher risk than fixed deposit.
The risks associated with bond fund are
- Interest rate risk – Associated with drop in bond price due to increase in interest rate
- Credit risk – Associated with timely payment of interest / principal from bond issuer
- Liquidity risk – Associated with difficulty to liquidating a bond in market
Among them, investors have to rely on fund manager to manage credit risk and liquidity risk by investing in quality bonds. The risk that investors need to be particularly cautious, is interest rate risk.
The interest payment (called coupon) and principal payment (called face value) are fixed at issuance of bond. As you can imagine, as interest rate goes up, the return of bond that has already been fixed at issuance, becomes less attractive (may even be lower than fixed deposit rate in extreme case). As a result, market value of bond goes down when interest rate goes up.
Bond fund as alternative of fixed deposit
Here are comparisons between fixed deposit and bond fund.
| Bond Fund | Fixed Deposit | |
| Risk | Low risk (see previous section) | Minimal risk |
| Liquidity | Around 1 week time for redemption | Immediate redemption |
| Maturity | No maturity, investor is entitled for return up to redemption date | Comes with maturity period. Loss of interest or interest penalty for pre-mature withdrawal |
In Malaysia, bond fund indeed has been a very good alternative to fixed deposit in the past 10 year until today. When bond is issued, the coupon rate is always fixed at a value higher rate than fixed deposit, i.e. interest payment from bond would be higher than interest provided fixed deposit. Another important factor is, bond price does not have much interest rate risk over the past 10 years, because OPR (overnight policy rate) has been pretty much stagnant as you can see from figure below.
From my observation, many investors might have forgotten that bond or bond fund could be hit by rising interest rate. In 2020, OPR rate has been adjusted down dramatically to mitigate economic risk due to COVID-19 pandemic. Low interest rate environment is expected to last for a period of time. When time comes for Bank Negara to normalize OPR, if the pace is too fast, bond fund could take a hit, I think this is something that we have to bear in mind.
Expected return of bond fund
Here are historical data of some bond funds to serve as reference how much return to expect. There is no investment suggestion, please consult your unit trust consultant before investment.
| Platform | 2019 | 2018 | 2017 | 2016 | 2015 | Sales Charge | Platform fee | Redemption fee | |
| KAF Bond Fund | Fundsupermart | 6.09% | 5.43% | 5.24% | 6.01% | 5.38% | X | X | X |
| RHB Bond Fund | Fundsupermart | 7.74% | 3.54% | 5.11% | 6.49% | 5.73% | X | X | 1% on 1st year 0% after 1st year |
| Kenanga Bond Fund | Fundsupermart | 4.58% | 3.76% | 3.76% | 3.81% | 2.45% | X | X | X |
| Affin Hwang Bond Fund | Fundsupermart | 7.64% | 5.16% | 5.06% | 4.71% | 2.82% | X | 0.05% per quarter | X |
| RHB Islamic Bond Fund | Fundsupermart | 3.63% | 4.01% | 4.92% | 6.37% | 6.78% | X | X | 1% on 1st year 0% after 1st year |
| Kenanga Asnitabond Fund | Fundsupermart | 7.5% | 4.58% | 4.56% | 6.17% | 5.1% | X | 0.05% per quarter | X |
| Maybank Malaysia Sukuk Fund | Fundsupermart | 8.61% | 5.08% | 4.57% | 4.19% | 2.79% | X | 0.05% per quarter | X |
| Public Bond Fund | Public Mutual | 7.09% | 4.19% | 3.74% | 4.75% | 4.22% | 1% | X | X |
| Public Islamic Bond Fund | Public Mutual | 8.21% | 4.85% | 2.94% | 7.13% | 3.77% | 1% | X | X |
My strategy
Bond fund is suitable to place money that would not be touched for 1 to 2 years time, especially if buying bond fund with sales charge upfront. Sales charge is one-time charge, therefore the return would not be so appealing if investment period is too short.
Personally I am using bond fund to park my emergency fund, and I’m buying through fundsupermart. For cash that needs to be very liquid to pay for daily expenses, I use Privilege Saver saving account from Standard Chartered that gives me interest rate higher than FD with some conditions. If you want to know more about this account, can refer to my previous article here.
Extended reading: 【2020】Simple trick that makes interest of your saving account higher than fixed deposit in Malaysia
As OPR was adjusted down dramatically this year, I would be very cautious about investing in bond fund if there are signs that Bank Negara would normalize OPR at a very fast pace. Having say that, I do not think this would happen at least until 2022 so I would still continue with current strategy at foreseeable future.
Disclaimer: I am not a unit trust agent/consultant. This article is purely for sharing purpose, no investment recommendation.