Tuesday 06 May 2014 by Elizabeth Moran Education (basics)

How to buy bonds

Simple explanations of how to invest in bonds in Australia with particular emphasis on the over-the-counter and ASX listed markets

Key points:
  1. There are two markets for direct bond ownership in Australia: the over-the-counter (OTC) market and the ASX listed market.
  2. Whether you buy bonds on the OTC or ASX listed markets, you will need arrangements in place to buy and sell as well as to hold those bonds in safe custody. Safe custody of bonds is like CHESS for shares and the beneficial ownership of the bonds always remains with the investor.
  3. FIIG has over 240 bonds available from $10,000.

There are two markets for direct bond ownership in Australia. The main market is the over-the-counter (OTC) market conducted by Austraclear (which is owned by the ASX). The other is the ASX listed market, which is much smaller and has a limited choice and liquidity but does offer a range of hybrid securities.

Whether you buy bonds on the OTC or ASX listed markets, you will need arrangements in place to buy and sell as well as to hold those bonds in safe custody. Safe custody of bonds is like CHESS for shares and the beneficial ownership of the bonds always remains with you, the investor. Most brokers will charge a fee to set up a custodial account, but this is not always the case.

Other indirect ways to access bonds include managed funds that are dedicated to bonds, funds with an allocation to bonds and exchange traded funds (ETFs), although many of the advantages of direct ownership are lost through these less transparent avenues.

The Australian OTC bond market operates like it does in most other countries around the world. Generally, direct investors use the services of a bond dealer/broker. First, you need to ascertain the bonds in which you would like to invest. Dealer/brokers can provide you with lists of bonds, prices, interest rates and research for you to decide which bonds to purchase to suit your requirements. Generally, bond dealer/brokers will buy the bonds you choose at one price and sell the bonds to you at a slightly higher price. This is called the margin and is how broker/dealers earn their revenue. Dealer/brokers generally also provide research, custodial and reporting services for your bond holdings at no additional charge. There are no other ongoing or management fees and investors know their projected returns when they buy bonds.

Many bonds trade in minimum face value parcels of $500,000 in the OTC market. However, some bond dealer/brokers provide services whereby bonds can be directly purchased by investors in smaller parcels sizes of $50,000 and $10,000. The company I work for, FIIG Securities has over 240 bonds available in smaller parcels from $10,000.

ASX listed bonds and hybrid securities don’t have any minimum purchase amount, but the range of available bonds and liquidity is small.

Government and semi-government bonds can be bought for as little as $1,000. A selection of Commonwealth government bonds is available via the ASX in the form of CHESS Depository Interests (CDI), while state and territory bonds can sometimes be bought direct from them or through a bond dealer/broker.

So, you can start to build a fixed income portfolio with a relatively small initial investment.

Once you have decided to invest, you need to consider where you think interest rates are headed for the next few years as this will help you determine your allocation to the three different types of bonds: fixed rate, floating and inflation linked. You also need to consider the return and thus the risk you are prepared to accept, any future dates when you may want to access funds (and link to maturity dates of the bonds).

A good dealer/broker can provide you with the information that you require to make these decisions. They should also provide you with dedicated fixed income research. Equity or share based research will be useful, but the drivers between the asset classes are different, so it is very important that they can show you fixed income research.

You then need to decide if the suggested bonds suit your needs. If not, the broker should make other suggestions until the right investments are identified. One of the attractions of direct investment is that it is a bespoke service, where you invest in the bonds that you choose to meet your needs; very much in tune with the SMSF investor psyche and requirements.

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