Did you know that in addition to issuing shares on the stock market, famous Australian companies like Qantas, Wesfarmers, and Woolworths also issue corporate bonds? These debt securities are a powerful alternative investment that can play a crucial role in diversifying a financial portfolio. Understanding corporate bonds is key to making informed investment decisions and building a resilient financial future.
What are Corporate Bonds?
A corporate bond is a form of debt security that enables companies to borrow money directly from investors. In exchange for this loan, the company promises to make regular interest payments to the investor and repay the original amount (principal) at a fixed date, known as the maturity date. They are one of the main types of investments within the broader fixed income category, with the other being government bonds.
Purchasing corporate bonds can be thought of as providing a loan to a company seeking to borrow money for expansion. For example, you could invest $1,000 in corporate bonds and receive 5% annual interest over 10 years. After 10 years, the company will repay the original $1,000, but you would have earned $500 in interest along the way. This structure makes corporate bonds distinct from equity and a valuable component of many investment strategies.
Four Reasons to Consider Corporate Bonds in a Portfolio
The argument for investing in corporate bonds is based on characteristics that distinguish them from shares and government bonds. Let’s examine some of these key differences that make them a compelling alternative asset.
Certainty over Principal Repayments
Like government debt, corporate bonds have a predetermined “maturity” date where the issuer must repay the principal. This is a significant difference from shares, where a company never needs to repay the capital you invested. Maturity dates for corporate bonds typically range from one to 30 years, offering flexibility for investors to align with their financial goals.
Predictable Interest Payments
Corporate bonds are an effective option for investors seeking to establish predictable income streams and have certainty about future cash flows. They offer a set schedule of either:
- Fixed payments: For example, 5% annually.
- Floating rate structures: For example, 2% above a specified reference rate (adjusted regularly).
A company is considered to be in default if it misses a single interest payment on a bond. Meanwhile, stock dividends are completely optional and up to the discretion of a company’s board, making it challenging to predict future income from shares. This predictability of interest payment is a major draw for corporate bond investors.
In addition to traditional bonds, the Trivesta Protected Yield Fund (TPYF) offers a fixed-income alternative for Australian investors. TPYF is structured as a high-quality managed fund that targets stable income with capital protection features.
Key features of TPYF include:
- 10% p.a. Target Return (Net of Fees): The fund aims for a 10% annual return, paid via a fixed distribution schedule.
- Monthly and Semi-Annual Payouts: Investors receive a fixed 0.5% monthly distribution, plus bonus distributions of 2% for the 6th and 12th investment months. TPYF delivers a consistent, fixed monthly income, rare among typical bond or cash funds.
- Fully Redeemable & Flexible: TPYF offers monthly full redemption with no penalty, giving investors liquidity on demand. Unlike locked-in term deposits, you can cash out according to a simple notice period.
TPYF complements traditional fixed income strategies and offers accessibility and consistency, especially for those seeking alternative investments in retirement.
Corporate Bonds Take Priority in Bankruptcy
In terms of their priority, in the event that a company goes bankrupt, corporate bonds are considered to be safer than shares. This is because bondholders are prioritised above shareholders in a company’s capital structure during bankruptcy. This offers an added layer of capital protection for those seeking more secure investment-grade options.
Higher Yields than Government Debt
Corporate bonds tend to offer higher yields than government bonds because they are generally considered to be a riskier investment. This is because there is a greater likelihood that a company may default on its bond payments compared to a government, which has the ability to raise taxes or print more money to meet its financial obligations. This makes them an attractive alternative investment for those seeking higher returns than safer government bonds.
How are Corporate Bonds Priced?
When a company is issuing corporate bonds, the interest rate is determined by factors such as current interest rates and investor demand.
After the bond is issued, the bond price may fluctuate like stock prices. However, corporate bond prices are typically less volatile than shares and are, to an extent, anchored to their face value, which is usually $100 in Australia.
Bond prices are affected by factors including evolving perceptions of an issuer’s creditworthiness and central bank interest rates. After the bond is issued, it may trade at a premium or discount to face value until reaching maturity. These changes will impact the yield received, depending on whether an investor buys the bond higher or lower than its face value in the secondary market. Recommended reading: Learn more about the different yield measures applied to fixed income securities and how to interpret them in this blog.
How to Access Corporate Bonds on the ASX
Historically, Australian investors have faced challenges in accessing corporate bonds. They are often traded between large institutions without ever being offered directly to everyday investors. However, exchange-traded funds (ETFs) are helping democratise investing in the Australian fixed income market. Today, a number of corporate bond ETFs exist on the ASX and these offer several benefits including:
- Diversification: Corporate bond ETFs allow investors to diversify their bond portfolio across a range of issuers, managing specific company risks. This is key to a balanced asset class approach.
- Access: ETFs trade on an exchange, making it easy for investors to buy and sell their holdings, enhancing liquidity compared to individual bonds.
- Regular income: Some corporate bond ETFs pay out interest monthly, providing regular cashflow to investors, with the option to reinvest their income.
What are the Risks of Corporate Bonds?
It’s important to be aware of the risks involved when investing in corporate bonds. These include:
- Default risk: The possibility that an issuer may not be able to make interest or principal payments as promised.
- Interest rate risk: Bond prices can be sensitive to changes in interest rates, particularly for bonds that are not due to be repaid for many years.
- Credit spread risk: In times of economic stress, the difference between the yield in corporate bonds and government debt may widen, leading to a decline in the value of corporate bonds relative to government bonds.
Specifically with fixed income ETFs, it’s important to keep in mind that bonds in ETF portfolios are continuously being added or removed due to securities reaching maturity and changes in the index. As a result, bond ETFs do not have a set maturity date, unlike individual bonds.
What are Credit Ratings?
In the same way that people have their own credit scores, corporations and governments have their credit ratings assessed by agencies like Standard & Poor’s, Fitch Ratings, and Moody’s. These agencies play a vital role in the bond markets.
They classify bonds as either:
- Investment-grade: Often scored between “AAA” to “BBB”, depending on the agency.
- Non-investment-grade: Also known as “high yield” or “junk bonds,” they are typically defined as those with a BB rating or lower.
Credit ratings are important to consider when evaluating the risk of a particular bond or bond portfolio. Fixed income ETFs usually disclose the weighted average credit rating of underlying bonds held. Diligent research, often involving fixed income articles or using trusted platforms, is essential for understanding these ratings.
How to Invest in Corporate Bonds
Betashares offers a range of fixed income funds that invest in corporate bonds, providing a simple and cost-effective way to add this asset class to your investment portfolio. This can be a key part of an effective retirement income strategy.
As with all ETFs, you can buy or sell units on the ASX using an online brokerage account or through a financial adviser, just like you’d buy or sell any share on the ASX. Always perform due diligence before investing in any alternative investment.
