Imagine you're lending money to a trusted partner who agrees to pay you back with interest over a set period. This is, in essence, what happens when you invest in bonds. However, instead of a partner, you're lending to governments, corporations, or supranational organisations. These entities require funding for their projects, and rather than relying solely on traditional loans, they issue bonds in the primary and capital markets to raise capital from investors like you.
Bonds can be purchased directly through a broker or indirectly by purchasing units in an institutional Collective Investment Undertaking (CIU) that has bond exposure. When investors purchase a bond, they enter into an agreement where the issuer, whether a government or a corporation, commits to repaying the principal amount along with interest. The returns you earn from this investment depend on several factors, including the issuer's financial health, economic conditions, and market sentiment. It’s more than just a loan—it's a strategic investment that can yield returns over time.
Consider a scenario where a company in Botswana needs to raise funds by issuing or selling bonds. This isn’t a straightforward task; it requires expertise and guidance, which is where banks play a pivotal role through the Corporate and Investment Banking (CIB) divisions. Specialised teams within the bank assist these companies throughout the process. The Investment Banking function supports the issuer to decide whether bonds are the most suitable option for raising funds or if offering equity (a share of the company) might be more appropriate. Additionally, they determine the bond's pricing and ensure compliance with the local stock exchange – in our case the Botswana Stock Exchange (BSE) - listing requirements, facilitating a smooth entry into the market.
Once the bonds are ready for issuance, the issuer/seller (with the support of investment bankers) engages with potential investors or buyers. This might include, for example, large institutional investors who typically manage significant sums of money. Banks are not only limited to the role of advisory in bond issuing; they can also participate as issuers and investors for their own balance sheet management purposes. In fact, the primary revenue line for traditional commercial banks is the net interest from interest-bearing assets and liabilities; bonds issued by the bank form part of the interest-bearing liabilities and bond investments form part of the assets. The Treasury function within the bank continuously monitors the main revenue line to determine the capital requirements for the bank and to generate income most prudently.
Institutional investors typically appoint asset managers to invest on their behalf and to make informed decisions about which bonds to buy. However, to safeguard these investments, custodians are brought into the picture. Custodians are specialised units within banks that provide safekeeping services which entail looking after financial assets on behalf of investors. In the context of bonds, Custodians ensure that these are kept safely on behalf of investors, facilitate exchange of title for payment as the asset manager buys and sells on behalf of the client, and service the asset by monitoring material events that create benefit or obligation on behalf of the investors. They also ensure that the bonds are properly registered as belonging to the investor and are segregated from the investments of other intermediaries and service providers that the investor employs. In addition, they manage any changes that might impact the bond, such as adjustments in the issuer's management or scheduled interest payments.
Furthermore, institutional investors often pool their resources into diversified investment vehicles that include bonds. These CIUs are managed by specialised companies but require oversight to ensure adherence to investment objectives and legal requirements. Trustees, which are typically banks, fulfil this role by ensuring that the CIUs operate in compliance with the trust deed and prospectus, maintaining the integrity of the investment process. Another important role played by banks is investment administration. This caters to reporting needs of institutional investors including and maintaining an accounting book of record, monitoring investment compliance and performance. These reports are essential for making informed decisions about future investment strategies.
Banks lend invaluable support through their global markets divisions for investors looking to expand their portfolios internationally. This team facilitates the purchase and sale of foreign bonds and helps manage the associated risks, such as exchange rate fluctuations. They provide access to global opportunities, enabling investors to diversify their holdings and potentially enhance returns.
Investing in bonds is a multifaceted process involving various stakeholders - including but not limited to banks – and with each playing a critical role. From advising issuers and safeguarding investments to exploring global markets, every step is interconnected, ensuring that your investment is managed professionally and efficiently. Whether you are looking to achieve steady returns or diversify your portfolio, understanding the bond market and its key players is essential to making informed investment decisions.