How to make big profits from bonds like City Bank Capital did 

Despite the fact that bond prices are less volatile compared to that of equity shares, the bond market might be volatile enough to offer you big capital gains, said bond expert Ershad Hossain, managing director and chief executive officer of merchant bank City Bank Capital Resources Ltd.

His firm, a pioneer in bond-related services in the Bangladesh capital market, generated around 35% annual return four-five years back by trading local treasury bonds, in contrast to the common belief that the bond market offers little.

Ershad Hossain, in a recent interview with The Business Standard, suggested having learned about bond investing, one can wait for macroeconomic situations that lead to changes in the direction of interest rates in the economy and trigger their buy-sell decisions in the secondary bond market.

For instance, the year his firm made a lot from trading treasury bonds was a time when interest rates were ready to head down. City Bank Capital bought treasury bonds and when interest rates went down, the bonds were selling higher in the market and the firm sold them to book a sizable capital gain.

Why declining interest rates push bond prices higher and vice-versa

Explaining the fundamental dynamics of bond prices going higher or lower, Ershad Hossain said when interest rates go lower, new bonds come to offer less interest than the already existing ones issued at a higher interest.

The market tends to offer more for the high-interest bonds until their yield reaches a level of the yield offered by the new, low-interest bonds. Yield is how much interest investors get from any bond against their secondary market purchase price of the bond unit at a particular time.

The investors' tendency to ensure a rational yield from all the bonds pushes bond prices higher when the interest rates go down, according to Ershad Hossain.

On the other hand, when interest rates begin to go up, existing bonds issued at a low interest become less attractive to the secondary market investors and they offer less for the bond units that lead to a price drop.

Bonds for a balanced investment portfolio

Bangladesh's capital market lacks education and awareness about bond investing, while bonds are important for building a balanced, diversified investment portfolio, Ershad Hossain said.

In stocks, one might end up having big profits or losses, while in Bangladesh a large number of investors regret their stock market losses ultimately. Also, bond trading in the secondary market might prove profitable or not.

But the big difference between the two is, if investors do not sell a bond before maturity they would end up getting the principal alongside the accrued interest.

And, if one picks the right bond before interest rates start to drop the asset class, on top of a decent money-back safeguard, offers bigger than average return.

Citing his decade-long experience in developed financial markets, Ershad Hossain said, investors with a high-risk tolerance might go for high-volatility assets like stocks, while ones with moderate risk tolerance should prefer a mixed portfolio of stocks, treasury bonds and some high-rated corporate bonds, preferably, asset-backed ones.

Potential of asset-backed bonds

The investment expert who served for the issuance and arrangement of the first private sector Sukuk in the country – Tk3,000 crore Beximco Green Sukuk – prefers asset-backed bonds as they are secured by the tangible asset purchased out of the investors' money and in case of default, the trustee sells out the asset to pay back investors.

Asset-backed bonds like Sukuk also is different from interest-bearing bonds.

In traditional bonds, the issuer borrows money from investors and pays periodical interest against it until maturity when the principal is returned.

In a Sukuk, investors are like house owners and they own the asset bought out of their money and the corporate entity is like the tenant as it uses the asset until maturity. The instrument offers a rental income instead of interest, which is Shariah-compliant.

Ershad Hossain believes asset-backed bonds will be more popular in Bangladesh in the coming days.

The CEO of the investment bank that has served the corporate issuers for the highest amount of funds collected from the debt market in total to date stresses a massive financial education for awareness about bonds.