Last week we took a look at the banking industry. Today, let’s try to talk about the capital market in simple terms. What does capital market mean anyway?

First, capital is the kind of money we need not just to cover our consumption requirements or for operating needs like buying merchandise for the purpose of selling shortly thereafter in order to recover quickly the invested capital over a very short period but more the type we require for the long haul. That is either to start up or restructure a business or expand it wherein the recovery of the capital will likely take a few years. In basketball parlance the exercise is similar to what UAAP schools would do to reboot its line-up.

Second, a market as we all know is where vendors and buyers meet to transact the purchase and sale of merchandise based on a market price that is set or has evolved as a consequence of other similar transactions taking place in the marketplace.

In a capital market therefore, “buyers” or borrowers who are in need of capital, virtually meet or are matched electronically with “vendors,” investors with available funds that can be deployed over a long period of time, in a marketplace or in an exchange, to transact a sale of the “merchandise” which in this case is long term money for a financial consideration which is the yield of the bonds in the form of interest or dividends and the promise of capital appreciation in the case of equity capital (which we will later talk about in another column) as the underlying financed business prospers and grows. There are typically no intermediaries in between such as banks that will make a “spread,” except for agents who facilitate the sale in exchange for a modest transaction commission. And because there are no regulatory imposed safety nets, i.e., reserve requirements, the transaction value is reduced to its purest level of the bid and offer prices. Consequently, the return to the investor is optimized whereas the cost to the borrower is minimized.

Clearly for any economy like the Philippines, a robust, deep and developed capital market is a critical component of the country’s development goals.

Let’s juxtapose the above in the context of our local scene.

What are the products available in our market?

The bond market in our country is dominated by the promissory notes of the largest issuer or borrower which is the Philippine government. These notes are Treasury Bills with maturities of less than one year (90,180 and 360 days) and Retail Treasury Bonds (RTBs) and Fixed Rate Treasury Notes (FXTN’s) that have longer maturities that could range anywhere from 3 years to as long as 25 years. For example just this week the government’s Bureau of the Treasury (BTRs) issued RTBs with a 3 year maturity earning an interest rate of 4.875% before withholding tax for an investment of as little as Pesos 5000. Compare this with a typical bank time deposit that yields only 2.65% which is the prevailing rate for the same tenor. From BTRs website they compute that after 3 years this particular RTB issue will give a return of P585 versus the bank time deposit that pays you only P318 .

These bonds are negotiable and liquid, thus enabling investors to cash in on their investment prior to its final maturity. They can be sold and transferred freely to other parties. All publicly issued bonds are listed in the Philippine Dealing and Exchange Corp. which is the country’s bond exchange. Thus, market prices of secondary trades or transactions after the initial offering are transparent to the public and serve as guide in the decision making by investors to either buy or sell a debt instrument. These market prices serve also as basis for “marking to market“ or revaluation of the investment portfolio of corporate holders of bonds, particularly the large listed corporations or banks as required by the accounting industry and regulatory authorities for proper disclosure purposes.

It is important to note that when you sell a bond ahead of its final maturity, you take a risk that the proceeds of your sale could be lower than your initial investment. Why is this so? When interest rates move upward either because of BSP’s concerns over inflation or increased capital needs of the private and public sector because of structural expenditures like the Build, Build, Build program of the government, this usually results in higher market interest rates. In such a scenario such as what we find ourselves in right now, investors who purchased bonds say in 2015 when interest rates were lower would find themselves under water if they were to unload their position now prior to the final maturity of the bonds down the road. It’s like dumping an import who turns out to be a dud in the middle of a basketball season after registering a 0-3 win loss slate start .

Other than government debt issuances, there are also corporate debt securities and the banking industry’s Long Term Negotiable Certificates of Deposit (LTNCDs) available in the market although nowhere near the outstanding volume of government issues. These bonds are largely issued by triple A rated household names like Ayala Corporation, Globe Telecom, Ayala Land, GT Capital Holdings, PLDT, SM Investments Corporation, JG Summit and Meralco. The coupons are benchmarked at a premium over government bonds with comparable tenors since the borrowing of a private corporation is considered to be of a lower credit category compared to government indebtedness, thus providing a more attractive return for the investors. LTNCDs which have maturities beyond 5 years provide a tax free break for individual investors, thus enhancing even more the return for the investor. And like the government bonds, these corporate debt securities and LTNCDs are also listed in the bond exchange facilitating its negotiability and liquidity enabling ease of purchase and sale for investors. These listed debt instruments can be purchased or sold through SEC licensed dealers and brokers.

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