Liz Moran looks at why corporate bonds are an attractive alternative investment during a low interest environment.
Risk is rising in markets, with many fund managers and self-managed superannuation funds (SMSFs) turning to cash for their defensive allocations. But deposit rates are very low and if you consider that inflation is running at around two per cent per annum and good one year major bank term deposit rates pay 2.4 per cent per annum, real yields are very skinny.
Investing in corporate bonds could be a good alternative. For slightly higher risk you can get slightly higher returns and importantly invest for a term that suits the client.
In such a low interest rate environment, and with little reason to expect rates to move much higher anytime soon, the longer a client sits in cash the more their overall portfolio returns are weighed down by this allocation. Also, the more work other allocations need to do to offset the low cash return.
While most investors in Australia are happy to lend to banks through term deposits, many investors are now making the decision to lend their money to the corporate sector by purchasing corporate bonds and benefiting from the higher returns available.
In many cases this means lending money to the same companies in which your clients would be happy holding the company’s shares.
Most investors in Australia would already own bonds in a super fund or via a managed fund or even an exchange traded fund (ETF). Very few of them would own bonds directly and know which companies they are lending to.
Seven reasons to suggest your clients invest in bonds:
1. The global bond market is roughly double the size of the global share market – it’s a big market and there is a broad range of bonds with various risk and reward attributes. The Australian market is estimated to be worth $1.6 trillion, yet many of our domestic bonds are sold to overseas investors, including private Asian buyers. Australian SMSFs are desperately underweight the asset class, missing out when many international super funds allocate more than 50 per cent of portfolios to bonds. Australian pension funds rank in the three lowest countries, alongside Poland and Korea with around 10 per cent allocated to bonds.
2. Corporate bonds are great diversifiers – they can be issued by companies not listed on the Australian Securities Exchange (ASX), including multi-national companies such as Apple, BMW, and Morgan Stanley – in Australian dollars. Investors can also buy bonds in foreign currencies, using funds they may already have in foreign denominations. Perhaps most importantly, corporate and government bonds diversify away from higher growth and higher risk asset classes, adding stability to many portfolios.
3. Returns are known upfront, few investments can provide that certainty.
4. Bonds have a maturity date, investors know when to expect repayments and can use the dates to help match known liabilities.
5. Interest can be paid quarterly or half yearly and in some cases monthly – retirees are often looking to replace a lost income and the frequency of bond payments – as, unlike shares, interest dates depend on when the bonds are issued. We have one bond that pays interest on Christmas Eve every year.
6. There are three types of bonds – fixed, floating, and inflation linked – so suitable throughout the economic cycle. Investors may have a preference for floating rate bonds when interest rates are rising. But if they are falling, investors would prefer fixed rate bonds that rise in price when interest rates are falling. Inflation linked bonds pay income linked to inflation, especially good for retirees who typically do not have adequate inflation protection.
7. Investing on behalf of your clients is now easier with bond individually managed accounts (IMAs) – managing a direct bond portfolio is time consuming, especially for active traders. This is still an excellent option for investors who want total control.
Liz Moran is director of research and education at FIIG Securities.