This article was originally published on 26 February 2018 and modified on 29 May 2019.
Simple explanations of how to invest in bonds in Australia with particular emphasis on the over-the-counter and ASX listed markets.
Key points: - There are two markets for direct bond ownership in Australia: the over-the-counter (OTC) market and the Australian Securities Exchange (ASX) listed market
- 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
- FIIG offers over 400 bonds in parcels from $10,000
1. Two markets
There are two markets for direct bond ownership in Australia. The main market is the over-the-counter (OTC) market (conducted by Austraclear). The other is the ASX listed market, which is much smaller and has limited choice and liquidity.
2. Accessing the markets
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.
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. For a list of advantages and disadvantages, see Direct investment vs managed funds and ETFs.
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, such as FIIG. First, you need to determine 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 spread and is how broker/dealers earn their revenue.
FIIG DirectBond and custodial service
If you choose to invest using our DirectBond service, FIIG’s custodial service saves you time and money by providing the following:
- Transaction settlements
- Collection and processing of payments, including coupons (interest payments) and maturity payments
- Foreign exchange
- Account administration including the processing of contract notes and corporate actions
- Reporting, including monthly and annual statements
As licensed custodial service providers, FIIG charges a custody service fee when you use our DirectBonds service. This is subject to a minimum monthly fee of:
- $20 if you nominate an existing Macquarie Bank CMA or elect to establish a new FIIG Funding Account held in your FIIG account name with Macquarie Bank; or
- $30 if you do not elect to have a Macquarie Bank CMA as your FIIG Funding Account.
The custody service fee is calculated daily on the value of your account holdings and charged monthly. The fee payable is based on the following table:
For example, if a client had $2 million to invest:
| Account holdings | Custody Service charge |
| For the first $500,000 | @ 0.20% pa |
| For the next $1,500,000 | @ 0.14% pa |
For more information, visit www.fiig.com.au/private/services/custodial-service
3. What can you buy?
Many bonds trade in minimum face value parcels of $500,000 in the OTC market. However, some bond dealer/brokers provide services where bonds can be directly purchased by investors in smaller parcels sizes of $50,000 and $10,000. FIIG Securities has over 400 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 is small and liquidity is low.
Government and semi-government bonds can be bought for as little as $1,000. A selection of Commonwealth government bonds are 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.
What’s next?
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.
Glossary
ASX
The Australian Stock Exchange (ASX) is a national organisation within Australia that enables electronic trading of shares and other securities through SEATS (stock exchange automated trading system).
Austraclear
An electronic system managed by the ASX for the settlement and registry of money market and fixed income securities.
CHESS
Clearing House Electronic Sub-register system.
Fixed rate bond
A fixed rate bond is a security that pays a fixed pre-determined distribution or coupon. The coupon of a fixed rate bond will be set at the time of issue and not change during the life of the bond. The Commonwealth Government, state governments, banks and corporates all issue fixed rate bonds in Australia.
Floating rate note
A floating rate note (FRN) or bond is a security that pays a coupon linked to a variable benchmark. In Australia most FRNs pay a coupon set as a margin above the bank bill swap rate (BBSW) which is the market benchmark three month interbank rate. The actual coupon for an interest period will be determined at the start of that period by applying the margin to the three month BBSW rate on the first day of the coupon period. The three month BBSW rate will rise and fall over time based on prevailing interest rates. The margin is fixed and will be set at the time of issue.
Government and semi-government bonds
Australian government bonds trade in amounts of $1,000, and interest payments and the re-payment of face value at maturity are Commonwealth Government guaranteed. Also known as Commonwealth Government Securities (CGS), government nominal bonds have maturities currently ranging from one year to 30 years, which may be bought and sold on the secondary market.
Hybrid securities
A broad classification for a group of securities, used by a range of corporations to raise money, that combine both debt and equity characteristics. These are usually higher risk investments due to their subordination in the capital structure. In Australia, the major banks are large issuers of these types of securities.
Index linked bonds
Index linked bonds are securities whose return includes a component that is determined by the future level of a predetermined index, for example; CPI or inflation. There are two main types of inflation linked bonds issued in Australia – capital indexed bonds (CIB) and indexed annuity bonds (IAB).
Maturity
This is the date when the bond is due for repayment by the issuer. The principal plus any outstanding interest of a particular security will be repaid on this date.
Minimum investment
Minimum amount required to invest in an offering or security.
Visit the FIIG website for more bond terms.