At a recent meeting held by the Malta Association of Small Shareholders, two representatives from BOV Asset Management Limited delivered a presentation about the differences between investment grade and sub investment grade bonds.

Mass is a voluntary organisation founded in 2011, with the main objective of increasing financial literacy among the local retail investor, by acquiring sufficient knowledge that can help them make informed decisions when investing.

Participants were addressed by Mark Agius, executive head at BOV Asset Management Limited, who explained that "BOV Asset Management Limited is committed to deliver a number of bespoke educational presentations aimed at increasing the level of knowledge about financial instruments both locally and internationally."

During the first part of the presentation, Rachel Meilak, Investment specialist at BOV Asset Management Limited, spoke about the classification of the bonds' universe by issuer, maturity, currency, type of coupon, region and credit rating. Meilak said: "It is of utmost importance to understand the use of credit ratings to distinguish between investment grade bonds (good quality bonds) and high yield bonds (lower quality bonds)." 

She continued to explain the role of rating agencies like Standards and Poor, Moody's and Fitch, which is to assess the credit risk, hence the probability of default and to assess the ability of the issuer to pay interest and capital on maturity.

Meilak said: "Credit rating agencies first analyse the credit risk associated with the bond issuers. In order to do this, they analyse the industry and company, assess the value of assets on the balance sheet, any covenants included in the prospectus and the company's strategy and track record, among other variables." 

She also explained that an investor needs to understand the limitations of credit ratings agencies, such as the fact that ratings normally lag the market's pricing of risk, which is not easily captured. Investors must be conscious that there is always an element of judgment. Over time, the bond issuer's credit rating may be upgraded but also downgraded.

In the second part of the presentation, Malcolm Abdilla Castillo, Senior Portfolio manager at BOV Asset Management Limited gave a detailed overview of the composition of bond yields as a component of the risk-free rate and a spread - the additional return for the higher credit risk, lack of liquidity or different maturity. Abdilla Castillo said that "all investors should understand how changes in the economic conditions, financial markets and general market demand and supply impact the yield spreads".

He continued by explaining that "a wider yield spread means lower bond prices and a higher compensation for risk".  He then went on to explain about the additional return earned between investment grade and high yield bonds to compensate for the higher credit risk.

He also spoke about the importance of understanding interest rate risk, through the bond's duration, which measures the extent to which the bond value changes as a result of changes in interest rates levels.  He explained that "duration risk is higher for bonds with a lower coupon and a longer maturity date".

Abdilla Castillo continued by expanding that from past performance we can learn that high yielding bonds tend to outperform investment grade bonds when the economy is experiencing a recovery and vice versa. Before concluding his intervention, Malcolm explained the difference between investing in direct bonds which carry a fixed rate of return and specific credit risks as opposed to investing in a managed fund with a variable return but a diversified credit risk. He said that with the latter "the investment manager can adjust the exposure to investment grade and non-investment grade depending on expectations of changes in economic conditions and yields, in order to achieve attractive risk adjusted returns".

After the presentation those present for the meeting had the chance to ask questions about the subject in question. Agius said that this presentation was one of a series and other presentations are planned for the coming months.