Are bonds the right investment, at all times?

Over the last few weeks, we have seen the successful issuance of two important bonds. The first was the €35m 5.35% MM Star Secured Bond due 2029/2034 and the second the €150m 5% Bank of Valletta Subordinated Bond due 2030-2035.

Both these bonds were well oversubscribed. The MM Star bond (a new name on the market) received interest of approximately €54m whereas the BOV bond attracted applications of approximately €183m. This is a reflection of the strong interest in local bond issuance and is a testament to the never-ending thirst that Maltese investors have for fixed-income securities. 

Local investors have always shown this tendency.  The presence of a clear coupon, which allows for the creation of an income stream as well as a fixed maturity (generally speaking), when investors know they will be receiving their capital back, are winning formulae.

It is strangely interesting though that some investors continue to adopt a strategy of buying such bonds directly when they are first issued and then largely tuck them away until they mature. This treatment of bonds as glorified deposits seems to form an integral part of an investment strategy that, somewhere along the way, seems to forget the need to assess the performance of the company, the risk the client is carrying and the overall place that that bond has in the investors’ portfolio. 

Bonds, like any other investment, carry risks, some significantly more than others, and one should not take comfort purely and solely from the fact that the market price of the bond has not moved.  Prices of local bonds are remarkably sticky and we have seen that even in the context of a company facing significant challenges, the price of the bond did not properly reflect the reality of the company.

The other interesting angle is in the way that some investors continue to use bond investments.  Investors who are looking to grow their capital as part of their retirement strategy ought to consider not only fixed-income investments but combine a greater use of equity-type products. It is true that equities give higher volatility and carry a greater risk of loss than bonds, however, in the long  term, equities always outperform bonds.

Recent data has shown that European equity markets have returned 8-10% over the long term (capital plus dividends), with government bonds in the 2-4% and corporate bonds offering 3-5%. This is not a small margin.  Over the average life of a local bond (10 years) this difference translates into a 40% higher capital value at the end of the period, through the use of equities rather than bonds.   

Ironically, equities are also more tax-efficient these days. Following the change in tax rules in 2022, there are no capital gains taxes to pay on shares that are listed on regulated exchanges.

While there is tax on the dividend income of such equities, the capital-gain part, which tends to be the more substantial part of the gain, is tax-free.

Consequently, investing in equities over the longer term not only gives you the benefit of compounding type return but these returns are currently largely tax-free. Using a properly diversified and structured portfolio should enable you also to achieve your investment objective in a manner that helps manage your risks too.

This is an important element because it is not only the investment return that should be considered but in conjunction with this the type of risks being taken to achieve this return. Ideally you also look at your risk-adjusted returns too, perhaps using ratios such as the Sharpe or Sciortino ratios, which in themselves are designed to measure the return per unit of risk taken. 

Alas, Maltese investors tend to be quite risk-averse, focussing predominantly on bonds. This is not a purely domestic phenomenon, rather a European one. Continental European investors have traditionally been fixed-income investors. In fact, direct equity ownership in counties like France and Germany is low at less than 5%.  This is probably a reflection of a mixture of elements such as cultural preferences, regulatory structures and possibly even by design. On the other hand, the US and the UK, including Anglo Saxon type countries, generally prefer investing in equities. 

While, over the short term, it is likely and important that fixed-income investments to remain the main focus, this space is likely to be shared more and more. The social mediafication of equity or ETF investment has certainly brought the benefits of buying equities closer to the surface. And the fund flows bear it out, as one can assess the amounts flowing into equity especially in Europe, vs that of the US. 

Yet missing out on good long-term investment planning can and will cost dearly, with the result only being apparent when it may be too late to change strategy.

David Curmi is chief officer – business development and client relationships at Curmi & Partners Ltd.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to any financial instruments, including those mentioned in this article. The value of investments may fall as well as rise and past performance is not indication of future returns. Curmi & Partners Ltd are founder members of the Malta Stock Exchange and are licensed by the MFSA to conduct investment services business.