Retail clients lured by yield are buying unlisted bonds without considering the high risks and whether they suit their investment profile, according to Morningstar.
Morningstar released its credit research titled ‘Not All Bonds are Created Equal: Looking behind the yield of unlisted bonds', which said unlisted bonds carries liquidity and credit risk, and said investors need to ask important questions before buying these bonds.
Liquidity risk is the ability to buy or sell a bond at an appropriate time at a fair price. But low levels of liquidity make it hard to buy or sell a bond, which means they may have to buy at an inflated price or sell while making a loss.
"Although investors may purchase bonds with the intention of holding to maturity, the scenario may still arise where these positions need to be sold, therefore investors should always be aware of the illiquidity of their investments," the report said.
Credit risk is the risk that the borrower, or bond issuer, defaults on a payment like a coupon or principal payment.
"An investor is essentially lending money to an issuer, so investors need to assess the issuer's ability to make timely distribution payments and return the principal on maturity," the report said.
"Credit risk is best assessed via credit analysis of the issuer and the bond in question. Unfortunately for many investors, this is beyond their expertise, so an alternative is needed."
Morningstar recommends investors insist on full fee and charge disclosure when dealing with direct bonds as the fee and commission structure is not as transparent as in the equity market.
Morningstar also said investors would be better of accessing the fixed income asset class through managed funds, exchange traded funds or listed alternatives.
