Financial jargon can sometimes sound intimidating, but when you understand the language, suddenly everything makes a lot more sense. The word ‘security’ can be particularly confusing because, in finance, it is often used to mean different things. In an investment context, a ‘security’ is a tradable financial product that can be bought and sold, such as a share or a bond. A debt security (also known as a fixed income security) specifically refers to an investment in debt.
Although there is a diverse range of debt securities, varying in form, feature and structure, they all essentially involve a business, government, or even a social impact project borrowing money from investors, with the promise of making repayments at agreed times and with an agreed interest rate. These repayments are generally in the form of fixed periodic interest payments. The investor knows how much interest or return they can expect to receive over the loan period, when they first buy the debt securities. Most commonly, the full loan amount (the principal amount) is required to be repaid in one lump sum when the loan reaches ‘maturity’. This ‘maturity date’ could be one year or several years after the debt securities are first issued, for example.
When businesses, governments or social impact projects raise money in this way, they are said to “issue” debt securities (sometimes called bonds or notes), just as businesses “issue” shares when they do an equity capital raise. Debt securities can also be bought or sold between two parties, in the same way shares can.
While most people are more familiar with the market for equity securities, the debt market is nearly twice its size, globally.
Equity securities, such as shares, represent a claim on any earnings (dividends) that are paid out by the business, or a claim on the assets of the business if it closes down. When an investor buys shares, they essentially buy a piece of the business. If the business profits, the investor profits as well, but if the business loses money, the shares lose value and the investor can also lose money.
On the other hand, when an investor buys debt securities from a business, such as bonds, they are effectively loaning the business money and will be repaid both the principal amount and interest on the bonds. If the business makes large profits, the value of the debt securities is unlikely to go up much, but similarly, if the business performs poorly, it will still have an obligation to repay the principal amount of the debt and any agreed interest. In the event of bankruptcy, a company repays investors who hold debt securities, before shareholders get anything.
Consequently, debt securities are considered to be lower risk and can be a more predictable income source than equity securities. However, as all investments offer a balance between risk and potential return, the return on debt securities is also considered to be lower, on average, compared with equity securities.
Catalist can facilitate investment in debt securities, issued by small and medium-sized businesses or social impact projects. Among other financial products, such as shares, our public market allows for periodic trading in debt securities. This means rather than trading continuously, investors can buy and sell debt securities at regular auctions.
With agreed interest rates, interest payments, maturity dates and a pre-determined auction schedule (when investments can be bought and sold), investing in debt securities on the Catalist platform allows investors to diversify their investment portfolio. This means they can benefit from supporting New Zealand businesses or social impact projects, with a higher certainty of returns than an investment in shares.
Interested in learning more? Whether you’re a business looking to issue debt securities, or an investor keen to explore the debt market, get in touch.
By Michelle Polglase