28 February 2011

Singapore Government Securities — An Alternative to Time Deposits?

When asked what could be done to help Singaporeans get more returns on their savings, Minister for Finance Tharman Shanmugaratnam told Parliament on 10 January 2011 that the prevailing low level of interest rates reflected loose global liquidity conditions.

The Singapore government did not make official forecasts of interest rates, but market analysts believed that the low interest rate environment could persist for some time in view of the weak recovery of the US and other developed economies.

Singapore's capital markets were developing, he said, and offered more investment alternatives including instruments that yielded better returns than savings deposits but without overly high risk.  Retail investors could participate in Singapore Government Securities ("SGS") auctions.  By mid-2011, they would be able to buy and sell SGS on the Singapore Exchange.  Well-rated corporate bonds were also becoming more widely available, as high quality borrowers were turning more to the bond market to meet their financing needs.  Some of those companies had begun to issue bonds aimed at retail investors.

Are SGS an alternative to bank deposits?

The prevailing yields on 5-year and 10-year benchmark SGS are approximately 1.2 per cent and 2.6 per cent, respectively, while the interest rate for 12-month time deposits is 0.5 per cent.  The yields on safer SGS are higher because of the longer time to maturity.

Unlike the interest rate of a floating rate note, however, the SGS yield is locked in at the point of purchase, so the yield advantage of the SGS vis-à-vis time deposits is eroded as interest rates rise.  Whether an investor is better off with SGS or time deposits depends on time deposit interest rates over the life of the SGS, but this is not something that he will know in advance.

An investor does not have to hold the SGS to maturity, however.  He can sell his SGS if there is a market for it.  If interest rates have risen, the price of his SGS may fall below the price at which he had bought it.  Generally, the longer the remaining time to maturity and the lower the coupon of the SGS, the more sensitive the price of the SGS is to movements in interest rates.  If an SGS is no longer a benchmark issue, demand for that SGS may be weaker than an otherwise similar benchmark SGS, and this may depress the price.  Finally, even in the best of circumstances, the bid price is lower than the offer price, and a buyer/seller also has to pay commission.

There is a place for SGS or investment grade corporate bonds in an investment portfolio, but probably not as an alternative to time deposits unless one is considering those with very short time to maturity.  Even then, the yield of a two-year benchmark SGS is comparable to, or (as is the case now) may even be less than, the interest rate of a 12-month time deposit.

The best time to buy an SGS or an investment grade corporate bond is when interest rates are high and expected to fall and remain low for an extended period thereafter.

Another possibility is to invest in a series of SGS (or investment grade corporate bonds) with staggered maturity dates so that in every period (for example, six months), an investor has an SGS of approximately equal principal amount maturing.  By so doing, he diversifies his yield risk and may outperform time deposit placements, though there is no assurance that any individual SGS will outperform a series of sequential time deposits during its life.

Notes.  "Inflation and Declining Interest Rates: Impact on Singapore households", Singapore Parliament report, 10 January 2011.

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