Investing in Bonds

Investing in bonds is one of the key elements of any diversified

investment strategy and an excellent way to reduce a portfolio’s

overall volatility while receiving regular interest payments.

While many investors are more familiar with shares, bonds are traditionally a strong performer and can add considerable growth and reliable income to an investment portfolio.

What are bonds?

Bonds are debt securities that are generally issued by corporations or governments and are a form of borrowing. If a company issues bonds, the money they receive is effectively a loan and that loan must be paid back to the owner of the bond at a set date in the future.

In a similar fashion to a home loan, repayments are made to the lender in the form of regular interest or coupon payments. Companies and governments are then able to use the money they receive from issuing bonds to fund their own operations and growth.

Bonds often pay a fixed rate, allowing the borrower to anticipate how much interest they are entitled to if the bonds are held to maturity.

Why invest in bonds?

Broadly speaking, bonds are far less likely have large price movements and as such have lower levels of volatility. At the same time, they pay out regular interest and investors received a fixed price at maturity.

Bonds are also an attractive hedge for an equities portfolio as they are traditionally inversely correlated and therefore as part of a diversified portfolio can offer a degree of downside protection when equity markets decline.

They are also generally highly secure in terms of the capital structure of a company.

Because bonds are a debt instrument, they have priority ahead of equity in the event of liquidation.

Bond Performance

Historically the performance of bonds will surprise many investors having performed incredibly well over a long period of time. In the last decade (see chart below), bonds have outperformed both Australian shares, listed property and international shares.

Typically on a longer time frame equities will out-perform bonds, however they still form an important part in reducing the overall volatility of a diversified investment portfolio.

investing in bonds

XTBs or exchange traded bonds issued offered by XTB offer a simple way to invest in income securities bringing together the predictable capital stability of corporate bonds and the transparency of the ASX.

XTBs are traded on the exchange, offering investors access to bonds which are usually inaccessible for retail investors.
Typically, corporate bonds have higher yields than government bonds, while a term deposit will generally have a higher yield than government bonds.

Essentially the more risk an investor takes, the more interest an investor should receive. XTB demonstrate this risk / reward profile with the following chart

investing in bonds asx

Types of bonds and other interest rate securities

Corporate

Corporate Bonds are issued by companies as a means to raise funds for their operations, for further growth or to expand.

Government and Semi-Government

Government bonds are issued by both the Commonwealth and State Governments. They are generally some of the safest bonds available.

Term Deposits

Generally speaking term deposits are fixed rate investments over a period of months to five years, with interest paid at maturity or annually.

Inflation Linked Bonds (Capital Linked Bonds & Indexed Annuity Bonds)

These are bonds where the interest paid is directly related to the current level of inflation or CPI.

Hybrids

Hybrid securities are a type of security which combine both debt and equity characteristics. Hybrids pay a predetermined rate of return or dividend until a certain date. At the end date of the investment, the hybrid may convert into the underlying ordinary shares of the issuer or a set amount will be paid back to the investor. Hybrids can offer the flexibility of both regular income and the potential for future growth. Hybrids are traded on the ASX and can fluctuate in price before the end date as expectations around the issuers ability to repay the hybrid change or as interest rates fluctuate.

Bond Yields

A bond yield is directly related to the level of risk the issuer represents. For example, bonds issued by the Commonwealth Government offer an incredibly low level of risk and are considered one of the safest investments vehicles available. Similarly, bonds issued by large Australian banks offer slightly higher returns, still with generally lower risk to investors when comparing other asset classes.

Understanding bonds

Fixed or Floating Rate

Bonds pay interest at fixed or floating rate. A floating rate bond is usually linked to a certain benchmark – in Australia this is usually the bank bill swap rate (BBSW)

Par Value

Bonds are generally issued with a par value of $100 or $1000 which is the amount the investor will expect to receive when the bond matures.

Discount and Premium

Bonds don’t trade at their par value throughout their duration. They trade at values above or below which are referred to as premium or discount.

Bond Maturity

The length of time until the bond comes due and the bondholder receives the par value of the bond. The maturity date is usually set when the bond is issued.

Yield to Maturity

The return an investor would receive if they purchased the bond at today’s valuation.

How to invest in bonds

Direct

In the case of unlisted bonds, investors can access bonds directly from the issuer. You will generally need to use a broker or advisory firm to gain access to these types of bonds directly. This is commonly known as using the primary market. Unlisted corporate bonds offer some of the best potential for strong yields. Trading Equities can provide clients with access to the latest issues in unlisted bonds.

Listed

In more recent times, some bonds have been listed directly on the ASX. XTB offer exchange traded bonds offering investors the ability to buy and sell via the exchange. Many of Australia’s largest and most sought-after companies and now available as listed bonds. Again, you’ll need a broker or trading account to gain access.

Bond ETFs

Exchange Traded Funds (ETFs) are an increasingly common and convenient way to get access to bonds. Bond ETFs trade directly on the ASX and seek to track a bond index. For example, the Vanguard Australian Government Bond Index Fund (VGB) seeks to track the Bloomberg AusBond Government 0+ Yr Index. For more information on investing in Bond ETFs please send us an email.

LICs

Active and passive investors can also gain access to a professionally managed portfolio of bonds by investing in Listed Investment Companies (LICs) that focus specifically on bond / income strategies.

Managed Funds

Many investors already have a degree of exposure to bonds through their super funds, however many might also have investments in managed funds that track or seek to outperform a bond index.

Strategies for Investing in Bonds

Depending on your requirements, there are many strategies that an investor can use to leverage the power and security of bonds.

Active Investors

Active investors seeking to achieve strong yields have the ability to directly access many of the unlisted corporate bond offerings in Australia. Corporate bonds have historically had strong returns with risk levels significantly lower than equities.

Active investment in corporate bonds gives, investors not only the ability to achieve strong yields, but also capital growth.

Passive Investors

Passive investors have access to a range of different strategies to gain exposure to bond markets. Typically, investors wanting to increase their bond allocation as a part of their overall portfolio may invest in Bond ETFs, bond based LICs and both listed and unlisted corporate bonds.

Building a diversified Bond Portfolio

For more information on investing in bonds or how a weighting towards bonds would complement your current portfolio feel free to contact us below.

Building a diversified Bond Portfolio

For more information on investing in bonds or how a weighting towards bonds would complement your current portfolio feel free to contact us below.

bonds

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