Understanding Corporate Bonds In Kenya

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Corporate bonds are ideal if you’re looking for a regular source of passive income.

They are not only safe but also stable and predictable. By owning them, you’ll know exactly how much money you’ll earn, when you’ll receive it, and for how long you’ll be getting it.

This makes them attractive to investors, especially because they offer higher returns than treasury bonds. But how, exactly, do they work? Where can you buy them and how do you make money from them?

Here’s everything you need to know about corporate bonds in Kenya.

What is a corporate bond?

Simply put, a corporate bond is a loan given to a company (or a corporation) by public investors.

It enables companies to raise capital for their business needs, which they use to fund specific objectives like exploring new markets, conducting research, or even launching new products.

In exchange, the company agrees to pay the lenders a specified interest payment for the entire loan duration, after which the principal is repaid.

How do corporate bonds work?

A corporate bond is a debt obligation. The borrowing company makes a legal commitment to pay interest (twice or thrice annually) to its lenders and then refund their principal once the loan period expires.

Whether or not the company makes a profit is irrelevant to the obligation - it’s still legally required to make the agreed interest payments to its lenders.

To put all this into perspective, consider this example:

If you invest KES 50,000/= in a 5-year bond paying a 12% fixed interest rate, you’ll earn 6,000 (i.e. 12% x 50,000) per year for 5 years. Once this duration is up, you’ll get a refund of your 50,000/= principal.

This kind of bond is called a fixed-rate bond. The rate was fixed at 12%, which the company had a legal obligation to pay annually. Fixed-rate bonds are the most common type of corporate bonds in Kenya.

Other types of corporate bonds include:

  • Zero-coupon bonds – which don’t pay interest until maturity, and;
  • Convertible bonds – which give the company the option to convert the payments to other forms (e.g. stocks instead of cash) when the bond matures.

There have been instances where companies issued zero-coupon bonds in Kenya. Just recently, Centum issued a 3-year, zero-coupon bond to fund the development of real estate projects.

Recommended: Bonds in Kenya - The Complete Beginner's Guide

Why invest in corporate bonds?

They provide a wide range of benefits including:

  • Income - Corporate bonds provide income in the form of regular interest payments to their investors. This gives them an edge over other investment types such as stocks, which are less certain and irregular in their returns.
  • Higher yields - they offer higher interest payments compared to government bonds with the same loan maturity.
  • Liquidity - Investors of corporate bonds can sell them and get their money back before the maturity since they have access to a secondary market. This enables them to find buyers for their bonds and offload them whenever the need arises.
  • Less risky - Compared to other asset types like stocks, corporate bonds are safer and more predictable. Companies need not be wildly successful to service their legal debt obligations, but they must thrive to pay dividends to their shareholders. This gives the bondholders more security over the shareholders.
  • Diversification - Given that they are safer and more certain, they can be used as a buffer to offset riskier and less certain investments like stocks. Also, you can invest in corporate bonds of various industries to shield yourself from industry-specific risks.

What are the risks of corporate bonds?

The cons of corporate bonds include:

  • Riskier than government bonds - granted, this is why corporate bonds pay higher interest rates than government bonds. Treasury bonds are more assured because the government could simply raise taxes to collect the money to meet its obligations.
  • Not insured - if the bond issuer goes bankrupt, you won’t just lose the promised interest payments, but the principal capital too. Bankrupt companies can (and do) default on their debts and leave their lenders with losses.
  • Require analysis - lending money to strong, credible companies requires due diligence, which involves analyzing company records to determine their financial strength. This requires work and skill to do well otherwise you might invest in a weak company.

How to buy corporate bonds

There are three ways to buy corporate bonds in Kenya: new issue, secondary market, and bond funds. Here’s a detailed look at each of these modes and how you can go about buying a bond.

  • New issue - Companies that are in fresh need of money usually issue their bonds directly to the public, who can buy them through CMA-licensed brokers. The company usually receives the proceeds directly and the broker charges a small fee for the service. For example, if you wanted to buy the Centum bond when the company first issued it, you’d have to go to a broker, place your order, and then the broker would buy it on your behalf. Centum would receive the money and the broker would get a fee for facilitating the order.
  • Secondary market - This is where already issued bonds are bought and sold by their current owners. A bondholder, in urgent need of cash, might decide to sell off his holdings before maturity. The secondary market links such investors with buyers who are willing to take over the bonds and their interest payments. In Kenya, pre-owned bonds can be bought or sold in the Nairobi Securities Exchange. The price of such bonds depends on the current interest rates and the financial condition of the company.
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A financially struggling company’s bond will typically sell at a lower price than its initial value. This compensates the new buyer for taking on the risk since the company is more likely to default.
  • Bond funds - these are a type of mutual fund, where investors pool their money under a professional fund manager, who analyzes the best bonds and buys them on behalf of the investors. Because the fund usually has a lot of capital at its disposal, it can afford to buy many bonds from various issuers, giving it the advantage of diversification.

Why you might prefer bond funds over other modes

Compared to the other modes, bond funds are more ideal for beginners because:

  1. They have low capital requirements - in Kenya, bonds are sold in multiples of KES 50,000, which can be too costly for beginners. Bond funds, however, allow for a minimum of even KES 1,000, making them both affordable and accessible.
  2. They are managed by pros - buying high-quality bonds involves doing financial analysis to ensure the issuing company is healthy and worth investing in. The fund managers running bond funds take on this technical role, meaning you don’t have to read through long financial reports.
  3. They are diversified - since they tend to have more capital at their disposal, bond funds invest in a variety of bonds. These may vary by maturity (long-term vs. short-term), industry (e.g. hospitality vs. telecom), and other relevant ways.
  4. They have higher liquidity - individual bondholders have to go to the secondary market, find buyers, and then go through a procedure to get their capital back. Investors of bond funds, on the other hand, simply need to contact the fund and withdraw their cash.

Are corporate bonds right for you?

Bonds are perfect for investors who:

  • Are looking for safety – Bonds are relatively safer than other investment assets like stocks. They are also much more stable and predictable in the way they pay their returns.
  • Want a regular source of income – Interest payments from bonds provide investors with a consistent stream of income. This is a good avenue for investors looking for a dependable investment asset.
  • Want to diversify – For investors who own risky assets like stocks, bonds can be used to balance their portfolios and cover their exposure. They are much more stable and predictable than stocks, so they can be used to offset some of the risks of your investment portfolio.

Key Takeaway:

Bonds offer a safe income stream for risk-averse investors, provided they invest in companies that are in good financial health.

The most ideal way to invest in them, for beginners, is through a bonds fund. Not only will they allow you to start investing with little capital, but you’ll also benefit from their professional management as well as their liquidity.