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Investment 101 – Perpetual Securities: Risks, Rewards and Guidance

Perpetual Securities: Risks, Rewards and Guidance

Perpetual securities, often referred to as “perps”, “perpetual bonds”, or “perpetual notes”, represent a unique category of investment instruments. Unlike conventional bonds, these securities do not have a maturity date, meaning they can theoretically exist forever.

Key aspects to note:

  • Perpetual securities, while seemingly similar to conventional bonds, should not be conflated with them.
  • An important feature of perpetual securities is the lack of a predetermined maturity date. This means that the issuer has the freedom to repay the principal whenever it chooses, which can be never.
  • As an investor in perpetual securities, you may potentially hold the security indefinitely. In such a case, you may not receive any return of principal if the issuer does not opt to redeem the security.

Understanding the nuanced characteristics and risks associated with perpetual securities is crucial for any investor contemplating investing in them.

Perpetual securities function differently from traditional bonds, featuring unique characteristics that potential investors should understand:

  • No Set Maturity: Unlike traditional bonds, perpetual securities do not have a predetermined maturity date, meaning that the issuer is under no obligation to repay the principal.
  • Variable Distributions: While perpetual securities typically offer fixed interest payments at regular intervals, the issuer reserves the right to cease these distributions without any requirement for consent. Importantly, such a halt does not signify a default by the issuer, though it may affect the security’s trading price and liquidity.
  • Scheduled Redemption Options: While issuers of perpetual securities may set specific call dates (such as the 3rd, 5th, or 10th year after the issue date) to redeem the securities, there’s no guarantee this option will be exercised. If not, the securities could potentially exist indefinitely, leaving the principal unreturned.
  • Interest Rate Increment Feature: Some perpetual securities incorporate a step-up provision, escalating the interest rate after a designated period if not redeemed. However, it’s important to note this does not assure that the issuer will opt for redemption before the interest rate hike comes into effect.
  • Lack of Voting Power: Investors in perpetual securities do not hold voting rights for significant corporate affairs such as major acquisitions, divestments, or fundamental business alterations.
  • Limited Protective Covenants: Perpetual securities may include few, if any, financial covenants, providing investors with limited protection. This lack of obligation on the issuer’s part to maintain financial prudence may impact their ability to meet obligations.
  • Risk in Liquidation or Default Scenarios: In situations of winding up or default, perpetual securities holders face the potential risk of losing part or all of their investment. This risk is compounded by the fact that a default in another borrowing by the issuer does not necessarily trigger a default for the perpetual securities.

Understanding these factors is crucial for investors contemplating investing in perpetual securities, given their unique risks and rewards.

Understanding the Risks Investing in perpetual securities carries several risks:

• Potential Infinite Holding: You could find yourself holding the perpetual securities indefinitely.

• No Guaranteed Reward: There’s no assurance of any return despite holding these securities in perpetuity.

• Reinvestment Risks: If your perpetual securities are redeemed, you might have to reinvest the proceeds in a lower-yielding market.

• Illiquidity: The secondary market for these securities might be illiquid, making it difficult to sell your perpetual securities.

Keep in mind, certain regulatory protections may not apply if you’re offered wholesale bonds and perpetual securities in sizes of $200,000 or more.

Exiting Your Investment

If the issuer doesn’t redeem the securities, your only exit strategy is selling them in the secondary market, assuming one exists. This exposes you to market price fluctuation and liquidity risks. Moreover, securities that are callable may have their market value capped by their redemption value on the next call date.

Why Perpetual Securities Yield More Than Bonds

Perpetual securities typically offer higher distributions than standard bonds of the same issuer. This compensates investors for higher risks, including the possibility of holding the securities indefinitely and the risk of deferred distributions that may not accrue interest.

Regular Credit Quality Assessment

It’s essential to carefully evaluate the issuer’s credit quality before buying perpetual securities and continue assessing it during your holding period. Keep an eye out for announcements or news relating to the securities or the issuer, especially if they are listed on the Singapore Exchange (SGX).

Interpreting Financial Statements

Whether the issuer is listed on SGX or not, regular disclosures of financial statements are necessary. You should pay close attention to these statements, annual reports, and any other documents that the issuer might publish.

Staying Informed through News Reports

Monitor news reports on the issuer’s financial position, industry outlook, and securities price movements. If you have any doubts, consider seeking professional advice. If you suspect the company is not complying with SGX’s listing rules or there might be market misconduct, you may wish to contact SGX, which is responsible for maintaining a fair, orderly, and informed market.

Navigating the Purchase and Sale of Perpetual Securities

Perpetual securities can be acquired in either the primary or secondary market.

Primary Market Purchase

Acquiring perpetual securities in the primary market involves subscribing to the initial offering from the issuer.

Public Offers: In the case of public offers made to retail investors, applications can be submitted through ATM or internet banking, similar to an initial public offering for shares. These offers are accompanied by a product highlight sheet, a prospectus, or an offer information statement. These documents detail the issuer’s information, securities’ terms and conditions, and related risks.

Private Offers: For private offers not available to the general retail public, subscription applications can be submitted through a bank or broker. Such offers usually come with an information memorandum.

Remember: Before investing, thoroughly review and understand the offer documents. If these documents are unclear, consider seeking professional advice or refraining from the investment. Ultimately, you are responsible for your investment decisions.

Secondary Market Trading

Perpetual securities can also be bought on the secondary market if traded on a platform like SGX. This transaction involves purchasing securities at the current market price through your broker, with brokerage fees applicable.

If you decide to sell your perpetual securities, this can also be done in the secondary market through your broker, similar to trading bonds and shares. Alternatively, you can wait for the issuer to call or redeem the perpetual securities, provided there is a call feature.

Understanding Default in Perpetual Securities A perpetual security is typically not considered in default if:

• The issuer doesn’t pay a distribution. As the issuer generally reserves the right to defer distribution payments indefinitely.

• The issuer doesn’t redeem the securities at a specific date. The perpetual security might give the issuer the option, but not the obligation, to redeem the securities at a specific date.

Always refer to your provided documentation to determine what constitutes an “event of default.” It typically only occurs when a court order has been made for the issuer to be wound up.

Therefore, holders of perpetual securities often resemble shareholders more than bondholders, given the lack of assurance for distributions or repayment of their investment principal.

Dealing with Liquidation of an Issuer

When a company goes into liquidation, it ceases its operations and its assets are sold. The proceeds from this sale are then distributed to creditors and shareholders. As a holder of perpetual securities, you typically rank behind senior creditors but before ordinary shareholders in the return of the issuer’s assets. This means you may lose a portion or all of your investment.

Payment Priority During Liquidation

An issuer’s debt may be divided into different classes—senior debt and junior debt. The priority of payment in a liquidation scenario is as follows:

  1. Senior/Secured debt
  2. Junior/Subordinated debt
  3. Perpetual securities
  4. Preference shares
  5. Ordinary shares

Do check where your perpetual securities rank. Generally, perpetual securities are considered junior/subordinated debt. Whether you and other creditors can recover all or a portion of your funds depends on the proceeds available from the liquidation.

Investing in Perpetual Securities: A Checklist

Before you invest in perpetual securities, it is essential to read the most current documentation available. If you are purchasing perpetual securities in the primary market, it is highly recommended to review the offering documents to better understand the offer and make an informed decision.

If investing in perpetual securities in the secondary market, you can obtain the offering documents and the latest updates about the companies from the SGX website (if the issuer is listed on SGX) or their respective corporate websites.

Understanding Your Suitability for Perpetual Securities

Perpetual securities aren’t suitable investments for everyone. They come with risks, including the potential loss of principal or capital. Therefore, it is crucial to evaluate whether this investment aligns with your personal circumstances.

Ask yourself the following questions:

• Can you withstand the potential loss of the principal? Given perpetual securities do not have maturity dates, you could lose all your invested money if no calls or distributions are made and the issuer is wound up or liquidated.

• Can you handle market price fluctuations caused by market conditions? These include interest rate changes as well as the issuer’s perceived credit quality.

• Can you bear a permanent income loss? The issuer could defer distributions indefinitely.

• Do you fully comprehend the features and risks of the investment? This includes the issuer’s ability to meet its distribution and other payment obligations, the factors influencing the market value of the investment, and the liquidity risk you face. Selling perpetual securities in the secondary market may be difficult, especially when you need cash urgently. You will also be subject to price risk.

Understanding the Investment’s Impact on Your Portfolio

You should also consider how the investment will affect the risk-return profile of your overall investment portfolio. For example, if the $200,000 you plan to invest in perpetual securities represents a significant portion of your overall investments, it could negatively impact the diversity of your portfolio.

Other Factors to Consider Comparing Returns and Risks Across Different Asset Classes for the Same Issuer

Here’s how various asset classes from a specific issuer compare:

Returns/Risks Bonds Perpetual Securities Preference Shares Ordinary Shares
Amount of Payout Received from Issuer Typically, holders receive the lowest payout compared to securities ranked lower issued by the same issuer. Holders typically receive higher distribution payments than bondholders who rank higher. Holders usually receive a higher dividend payout than bondholders and perpetual security holders, which rank higher. The dividend payout depends on the company’s profitability.
Coupon/Distribution/Dividend Payouts Typically paid before perpetual security holders, preference shareholders, and ordinary shareholders. Paid after those ranked higher are paid. The issuer has the right to defer distribution payments. Dividends are paid after bond and perpetual security holders, which rank higher, are paid. Shareholders are the last to receive dividends.
Investment Risk (Underperformance in Return and Risk of Losing Some or All of Investment) Generally lowest compared to other securities issued by the same issuer Typically medium Usually medium Generally highest
In Event of Liquidation Paid before perpetual security holders and shareholders Paid after bondholders Paid after perpetual security holders Last to receive any payout

This table can give you an idea of the relative risks and rewards of different types of investments with the same issuer. Keep in mind that this is a general guideline, and the specifics can vary based on the issuer and the terms of the securities.

A Trustee’s Role in Perpetual Securities

A trustee plays a pivotal role in safeguarding the interests of the perpetual securities holders. Here’s a more detailed breakdown of their responsibilities:

  1. Fiduciary Duty: The trustee owes a fiduciary duty to the perpetual securities holders, which means they must act in the best interest of these holders. They must exercise reasonable care and skill to ensure that the issuer abides by the terms set out in the trust deed.
  2. Liaison: The trustee acts as a liaison between the issuer and the perpetual securities holders. They communicate any important information between these two parties, such as any breaches of covenants or default events.
  3. Enforcement of Rights: If an event of default occurs, the trustee may take action on behalf of the perpetual securities holders to enforce their rights. This could include taking legal action against the issuer. However, the trustee may require indemnification or pre-funding from the security holders before taking such actions to cover potential costs or liabilities.
  4. Administration: The trustee is responsible for administrating the terms of the trust deed. This includes overseeing any amendments to the terms, coordinating with the issuer on payment of distributions, and facilitating meetings between the issuer and the security holders if needed.

However, it’s important to note that while trustees play an important role, they do not have an obligation to actively monitor the financial health of the issuer. The responsibility of evaluating the risk of the investment still lies with the individual investor. Therefore, it’s crucial for investors to continue monitoring their investment and the issuer’s performance and financial health independently.

Investing in perpetual securities is a decision that requires comprehensive understanding and careful consideration. With potential higher yields, these instruments carry a distinct set of risks, including the indefinite nature of the investment, market price fluctuations, and possible income loss. It’s crucial to thoroughly assess the credit quality of the issuer and understand how the investment fits into your overall portfolio.

Whether you’re a seasoned investor or just starting, our expert financial advisors can guide you in making informed decisions that align with your financial goals. Get in touch with us today for a personalized financial plan, and let us help you navigate the complexities of investing in perpetual securities. Invest smartly, invest confidently.

Investing in perpetual securities presents both exciting opportunities and intricate challenges. The landscape is intricate but, with careful navigation and informed decisions, there’s potential for rewarding outcomes. Embracing knowledge, staying vigilant about the issuer’s health, and leveraging expert insights can pave the way for a fruitful investment journey. Bright horizons await those who dare to venture with information and wisdom at their side.

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