The corporate bond education hub

The corporate bond education hub provides access to a comprehensive range of basic and advanced educational fixed income articles brought to you by FIIG, the fixed income experts. Through market-leading research and thought leadership, we empower investors and their advisors with knowledge and insights.

Chapter 1 - What are the different types of bonds?

What is a bond?

Even if you’re a complete newcomer to the world of capital markets, you probably understand more about bonds than you realise. A ‘bond’ is a type of ‘debt’. Deposits are classified as a type of bank debt. The bank must repay you at maturity You can start to understand some of the concepts of a bond investment.

Simply, when an investor purchases a bond it represents a loan to the bond’s issuer, which could be a bank, government, or corporation, in exchange for regular interest payments, over a set period of time, plus repayment of the face value of the bond when it matures.

A key feature of a bond that separates it from shares (otherwise known as equities) is that an investor will receive regular income and the initial value of their investment at maturity as long as the issuer continues to operate. For the vast majority of bonds, you can rely on these payments. For example, if you invest in a 10-year Australian Government bond you will continue to receive income on that bond until the bond matures unless the Reserve Bank of Australia (RBA) defaults.

This is why bonds come under a category known as ‘fixed income’. Although there are several forms of bonds, they are typically considered defensive assets, although some pay equity like returns and are higher risk

For more information on bonds and the benefits of investing in bonds read the full wire post

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Three types of bonds: part 1 - Fixed-rate bonds

A fixed rate bond is a security that pays a set, predetermined rate of interest (known as a coupon). A fixed-rate bond’s interest rate will be confirmed at the time of issue and will not change during the life of the bond. As a result, the prices of fixed-rate bonds can vary considerably as their price is linked to, among other things, interest rates.

Fixed rate bonds add interest rate ‘risk’ to your portfolio in that the only way these bonds can reflect changes in market expectations of interest rates is through a change in the price of the bond. If interest rates fall, fixed-rate bond prices will rise. The opposite is also true if interest rates rise, fixed-rate bond prices will fall.

These bonds are considered a staple of a standard diversified portfolio as they tend to be counter-cyclical, meaning they will perform well in a contracting economy when other investments are losing value.

To learn more about how changing interest rates impact bond prices read the full Wire post

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Three types of bonds: part 2 - Floating rate notes

Income on a floating rate note (FRN), also called a floating rate bond, varies according to interest rate expectations. Every quarter interest rates are reset according to a variable benchmark and in Australia that’s commonly the bank bill swap rate (BBSW). At maturity, the last interest payment plus the original face value of the investment will be paid.

Due to their ability to reset their interest rates to better reflect the current interest rate environment, these bonds can be used to protect a portfolio when interest rates are expected to rise. Therefore, FRNs can be used to offset the interest rate risk introduced by a fixed rate bond.

To learn more about how FRN’s are more capital stable than fixed rate bonds read the full wire post

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A guide to floating rate notes

There is a very wide range of floating rate bonds available and the main issuers in Australia are domestic and international corporations and institutions and, once issued, they trade on the secondary market. International organisations will also issue bonds in Australian dollars.

Different types of FRNs carry various risk profiles ranging from those considered extremely low-risk such as AAA-rated senior secured covered bank bonds down to those issued by institutions with a sub investment grade credit rating or no rating.

To learn more about how floating rate notes largely remove interest rate risk and make great alternatives to deposits read the full Wire post

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A bird's eye view on fixed and floating rate bonds

For a more detailed breakdown on how fixed and floating rate bonds can complement each other and enhance your portfolio please follow the link below to access a webinar mini-series hosted by FIIG.

View the fixed rate bond webinar and floating rate note webinar

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Three types of bonds: part 3 - inflation-linked bonds

An inflation-linked bond (ILB) is the only investment that provides a direct hedge against inflation.

To learn more about the two main types of inflation linked bonds read the full Wire post

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

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Chapter 2 - Busting myths about bonds

Myth #1: my portfolio consists of shares and cash and I don’t need a bond exposure

Reality: bonds protect your portfolio in ways that shares and cash do not.

To learn why bonds are lower risk investment than shares read the full Wire post

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Myth #2: it’s a bad idea to invest in bonds when interest rates or inflation are rising

Reality: Only fixed-rate bonds are directly impacted by a rise in interest rate expectations and the markets’ expectation of future interest rate rises are already built into the price.

To learn more about how different types of bonds work best in different economic cycles read the full Wire post

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Myth #3: bonds are too risky

Reality: comparing like for like, in the same company, bonds are less risky than shares.

One of the main, protective features of bonds, compared to shares is that they have a maturity date, where the company issuing the bonds, guarantees to pay face value. Shares have no maturity date and returns are unknown until an investor decides to sell.

Bonds are lower risk than shares in the same company – find out why by reading this article.

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Myth #4: fixed income returns are low and will be a drag on my portfolio’s performance

Reality: rating the quality of an asset’s returns must always be seen through the lens of its risk/reward ratio.

Whether you consider bonds to be a drag on your portfolio’s performance depends entirely on the market environment you’re operating in. In the instance of a severe correction, your AAA-rated fixed-income bonds may outperform your shares portfolio.

To learn more about how bonds help smooth overall returns in stressed markets read the full wire post

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Myth #5: you need a lot of money to buy bonds directly so go for a managed fund instead

Reality: The minimum investment in direct bonds is much lower than it used to be, enabling broader access to the asset class.

If you invest directly in bonds, you have control over which companies you invest in, when you buy and sell bonds, the benefit of knowing when interest will be paid to you and how much will be paid and you can take advantage of the natural maturity of bonds to have capital returned to you. But, it is more expensive than using managed funds.

Unlike managed funds where you pay ongoing management and performance fees, the cost to invest in the over-the-counter (OTC) bond market is built into the rates of return.

To learn more about how retail and wholesale investors can now invest in the over-the-counter, institutional bond market from $10,000 per bond with a minimum upfront investment of $50,000 read the full Wire post

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Myth #6: there is too long to wait until maturity

Reality: once bonds are issued they are traded in the secondary market. You can buy bonds that are close to maturity.

Bonds can be issued with very long terms to maturity. Some have 20, 30 or even 50 years until they mature and capital is repaid to you, but that isn’t your only option. The bond market is large and very liquid and you can typically sell your bonds at short notice.

Don’t be put off by the long terms. For the list of reasons why, read the full wire post

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Myth #7: I own hybrids so I already have an allocation to fixed income

Reality: hybrids were traditionally part debt and part equity. However, recent bank issues are much more like equity and do not provide the same level of protection in a downturn.

Most bank hybrids are perpetual, meaning there is no defined maturity date. Many corporate hybrids also have very long terms until maturity. Some are as high as 60 years, which means you will likely have to sell the hybrid to get your capital back.

Hybrids typically contain clauses with a call or conversion date before final maturity but there are usually conditions attached and the dates are by no means guaranteed with the power in the hands of the issuer. This is in stark contrast to bonds and deposits, which have known interest payments and maturity dates.

To learn why it’s important to own a range of fixed income investments read the full wire post

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

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Chapter 3 - Getting started with bond investments

How to buy bonds

There are two markets for direct bond ownership in Australia. The main market is the over-the-counter (OTC) bond market conducted by Austraclear, which is owned by the Australian Securities Exchange (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 the investor.

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

To learn more about how to buy bonds read the full Wire post

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Which is the best way to invest in corporate bonds?

As mentioned above, corporate bonds can be accessed either directly or indirectly via the OTC market or on the ASX listed market.

Four of the main advantages of investing directly in bonds are:

  1. Funds are returned to you at maturity
  2. Interest is set and predetermined at the time you buy the bonds
  3. Investment decisions are based on expected future returns
  4. The opportunity to outperform by investing in and trading a smaller number of good relative value bonds

In comparison, investors in managed funds do not enjoy any of these benefits, but they do offer retail investors access to financial tools they might not otherwise get. You’ll need to decide if you want a passive fund (where there is no or little oversight) and the fund aims to beat a benchmark or an actively managed fund that is overseen by a portfolio manager. The distinction is often reflected in the fees, where higher fees are charged for active management. Returns for active funds can significantly outperform passive funds, but this is not always the case.

ETFs, on the other hand, are usually structured as a managed investment scheme, where investors hold units in a trust. They can be great tools for retail investors to access markets where only institutional investors existed just over a decade ago.

For more information on the seven considerations to help you decide how to invest in bonds read the full Wire post

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Building a bond portfolio

Rule one of building any portfolio is maintaining a diversity of asset classes that hedge against each other. Bonds are a great diversifier and can help protect your wealth and income throughout various economic cycles while providing better returns than term deposits.

If you are new to bond investment, here are the answers to common investment questions that may help you determine how much of your portfolio you should allocate to defensive assets.

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

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Chapter 4 - Assessing bonds: what to consider

Top 10 tips for assessing bonds

We’ve reviewed the top 10 factors to consider before purchasing any bond, which means there’s more to it than simply checking the returns. Key points include analysing the liquidity of the bond pool for the issuer, and how the bond stacks up against other types of company investments in terms of its risk/reward ratio.

It’s also essential to be confident that the company will survive until your bond’s maturity date, and if that’s in any doubt you must know where your bond sits on the capital structure. These aspects are covered in more detail in the next section.

Check out the link to see all 10 tips.

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Top 6 tips to assess a company that issues bonds

You may already own shares in a company, but now you’re looking to expand your portfolio with bonds. As a prospective bond investor, there are critical differences when assessing bonds compared to shares.

For instance, there is the way we consider growth prospects. Strong growth prospects are positive for a shareholder as they should drive higher share prices and dividends. However, it can be a negative for a bond investor as the company will likely be taking on more debt and risk, and investing capital that may not return a profit.

There are many other criteria that bond investors use that are different to share investors. The training needed to become a credit analyst takes years but here are six key tips to get you started.

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

Chapter 5 - Diversifying your bond investments

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Nine considerations for building a diversified bond portfolio

Over the years, we’ve continually recommended that portfolios should not be 100 percent invested in a single asset class, let alone a single venture. A good starting point would be to include equally proportionate holdings of the three types of bonds we previously outlined in your portfolio.

Regardless of current economic climates and outlooks, investors should always have a plan that protects against unexpected future events. Other considerations include asking: what is your risk appetite? How liquid is your portfolio? How much income do you need to maintain your lifestyle?

See the full list for more details, or read on to the next section for graphical examples.

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Constructing a diversified bond portfolio

No matter what the current economic conditions are, there is always a risk of conditions changing suddenly. For example, today’s investor could be easily forgiven for assuming that inflation is under control and unlikely to suddenly jump. An investor in 1970 could have been forgiven for feeling the same way as, in the 20 years prior, inflation had averaged 2 percent to 3 percent per annum. However, in the 1970s, inflation spiked to more than 15 percent per annum, reducing real wealth by half in just five years.  

Investors should always have a plan that includes protection against the unexpected. A defensive approach means that you hold all three types of bonds but adjust the relative proportions according to where you expect the economy to go.

To learn more about building a defensive portfolio, tailored to your economic expectations  read the full Wire post

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Three ways to increase your returns

There’s no escaping it, increasing your returns means taking on more risk.

Three ways that an investor can take on higher risk are by agreeing to part with their money for longer, by accepting weaker rights over the issuer’s assets, or by investing in companies that are more at risk of failure.

It’s important to understand that not all risks are born equal and knowing which risks fit best with your investment strategy. As your strategy shifts to take on more risk, it’s also vital to pay even closer attention to ensuring appropriate diversification to offset that increased risk.

To learn more about how to increase your returns read the full Wire post

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Three couples, three completely different portfolios

We’ve created three real-life case studies of different people’s investment strategies that include corporate bonds which you can see here. Each couple represents a different approach to bond investment that aligns with their different goals.

Click here to read the case studies

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

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Chapter 6  - How risky are bonds?

The difference between bonds and shares in a severe correction

During severe market volatility, such as that experienced during the 2007/8 financial crisis, bonds and shares had diametrically opposite reactions to the turmoil. Although we cannot guarantee how the market will behave during future corrections, some trends are observable.

Firstly, those bonds with AAA ratings, such as Australian government bonds were sought after as they were deemed ‘safe-haven investments’ and bond prices rose.

Bonds are often considered safe-haven investments during market volatility because, unlike dividends on shares, interest income on bonds cannot be cut, so as long as the company or government survives, income is paid to investors.

To learn more about the difference between bonds and shares in a severs correction read the full Wire article

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The top 10 bond risks you need to know

Although bonds are among the safer investments in the market today, they still offer a variety of risks that must be taken into account. Beyond risks we already outlined in previous sections of this guide, such as default risk and interest rate risk, there are several others to consider.

For the full list of bond risks you need to know before investing read the full Wire article

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Quantifying the risk of bonds with S&P credit ratings

One of the primary ways market risks are quantified is through global credit rating agencies such as Standard and Poor’s (S&P), Global, Moody’s and Fitch. They analyse the credit worthiness of bond issuers and individual bonds and report on credit rating changes, as well as defaults.

Bond investors are able to gauge the riskiness of a venture, in part, by reviewing the issuers credit rating. Some institutional investors require bonds to have at least two credit ratings.

The credit ratings provide some insight into the level of risk for investors, but should never be relied upon or used in isolation.

For more information on quantifying the risk of bonds with S&P credit ratings read the full Wire article

To learn more about investing in bonds visit the other chapters in our Corporate Bond Education Hub

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