The international bonds market has seen a dramatic turnaround during the past 12 months. Initially offering returns of 10 to 20 per cent to anyone who would buy a company's debt, it is now yielding much lower returns - but still significantly higher than leaving money in a deposit account with a bank.

In the US, junk bonds (bonds that are non-investment grade) have given a return of nearly 50 per cent for the year compared with a still respectable 13.5 per cent for the Standard and Poor's 500 stock index. Things are now changing and the risk premium on junk bonds over the risk free treasuries is down to 7.5 per cent.

Locally, some corporate bonds with a 10-year maturity are offering a yield that is up to three per cent higher than the low-risk government bonds. In fact, if I recall correctly, one issue of government bonds was not fully taken up, probably because it was not offering a sufficiently attractive return to investors who are seeing their appetite for risk returning.

In Malta, the corporate bond market has behaved somewhat differently. Practically every corporate bond issued this year has been oversubscribed. The media, politicians and many columnists have invariably interpreted this phenomenon as a vote of confidence of the investing public in our economy and in those who mange it.

Others, who are perhaps more circumspect and less euphoric, stop and think before they jump to such conclusions. The current historically low interest rates are forcing banks to offer very low returns on their long term deposits. In our case, because of our stubbornly high inflation, some of the bank deposit rates are in fact negative in real terms because they are below the rate of inflation.

Unsophisticated investors who depend on their interest income are dangerously ignoring the risk factor associated with certain corporate bonds and rushing into buying any instrument that promises them a higher return. So far we have not had any major incidents of any corporate bond issuer failing to honour his interest or capital repayment obligations. This is probably encouraging a sense of complacency about the implied risk of high-yield local bonds.

Those with their ears close to the ground must know of some near misses in the last few years. They also know how certain corporate defaults were avoided by operators in the financial markets bending over backwards to accommodate distressed issuers by granting facilities to prevent a default. These operators rightly argue that one major default by a corporate bond issuer in such a small market is enough to irrevocably shake investor confidence. But there are no guarantees that in future such rescues will still be feasible and available.

Small investors need to be protected in various ways. Firstly, anyone issuing bonds should be obliged to explain in plain simple language, devoid of jargon and technicalities, the risks involved in investing in his business. The statistical probability of default linked to every single issue should also be clearly spelt out in the offering document.

This can be achieved if the Malta Stock Exchange insists on all bond issues being rated by an independent agency.

Corporate debt is already being rated with systems made available by major rating agencies, like Moody's and Standard and Poor's. The ordinary public has a right to know what risk they are taking when they buy commercial paper, especially at a time when banks seem to be shying away from taking on this debt themselves.

Investor education is another important consideration. Unsophisticated investors should be urged to look beyond the headline grabbing coupon figure. They need to know what the money is being used for and avoid those issues that are serving merely to provide an exit route to tired shareholders, unless they are offered much higher premiums for taking on such risks.

The culture of rewarding financial services salespeople through commissions linked to sales volume also needs to be managed conscientiously, if we are to avoid giving our small investors a raw deal by selling them products that are not suitable for them.

So, despite the fanfare that accompanies every local bond issue, the time is ripe to review the way we sell investments to ordinary people to avoid the current boom from turning into a painful bust in a few years time.

johncassarwhite@yahoo.com

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