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In this Q&A Mark Todd, director of Fixed Income at NAB, gives a rundown on the investment opportunities in the burgeoning corporate bonds market.
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Opportunities in the corporate bond market
26 August 2014
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13 minute read
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**This article has been prepared for education and information purposes and does not constitute financial product advice.**
What exactly are debt securities?
Debt securities are an ‘I owe you’ that can be issued by companies and governments. It’s an agreement to borrow money and repay it, plus interest, over a set period of time. Corporate bonds trade at a higher margin because government bonds virtually have a risk-free curve, whereas corporate bonds carry more risk. For example, NAB issues a debt security and agrees to repay the money lent to them on a specified date. NAB also agrees to pay (for the life of the security) an agreed spread to bank bills or a fixed interest coupon.
What are the different types of corporate bonds available to investors?
The majority of the fixed income market is made up of fixed rate bonds, which are bonds with a fixed coupon. Floating rate bonds are bonds that deal as a margin to the bank bill swap rate (BBSW), and the last bond is the inflation-linked bond where the performance of the bond is linked to the quoted inflation number. There are other types of bonds but these constitute the majority.
Why should investors include corporate bonds in their asset portfolio?
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There are a few reasons. The first is the benefit of having a balanced portfolio of assets. Depending on your circumstances, it may be wise to extend your investment options to include corporate bonds as well as equities and property. The investor then needs to look at their personal circumstances.
Things to consider include:
• Are my goals changing as I’m getting older?
• Have I made my money?
• If my capital increased, do I want to protect that capital?
• Do I need regular income as I’m preparing for retirement?
• Am I’m looking to have something that will pay me consistently without having to delve into my capital?
Bonds may play that role as they have consistent coupons; investors who attempt to match liabilities with income need not unnecessarily trade their equity portfolio. I’m not suggesting that one avoid equities, I’m saying start balancing your portfolio around your needs as you get older. It’s not just the consistent revenue; it’s the lack of volatility. Senior bonds are less volatile than subordinated bonds and are much less volatile than equity.
What type of person typically invests in corporate bonds?
People who want less volatile performances are the ones typically investing in bonds. There’s less risk, but one of the real themes in this asset class is the volatility – investors are buying higher-ranked assets that produce regular income in a low-volatile manner. This is popular with investors, particularly those with SMSFs who have been buying stable dividend paying equities.
Do a lot of SMSF investors get involved in corporate bonds?
It’s definitely a growing market. Investors bought into fixed income assets during the GFC. Term deposits were popular because deposit rates were high at the time as the banks needed funding. Term deposits are a security with a consistent coupon, but since rates have dropped investors have been looking at alternatives. I see some funds going into the equity market but there’s a challenge in the equity market in that it’s rallied so far already there’s a question around how much further it will go. Investors aren’t inclined to buy the small cap equities; they’re more inclined to buy the dividend payers, something I think of as investment in ‘bond-like’ equities because they offer consistent earning through dividends. Now, investors are looking for alternatives including the bond market and NAB’s job is to fund Australia’s future by being part of this bond market.
Disclaimer
The information contained herein has been prepared by National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) (“NAB”). The information does not constitute, in any jurisdiction, a recommendation, invitation, offer, or solicitation or inducement to buy or sell any financial instrument or product, or to engage in or refrain from engaging in any transaction. It is not the intention of NAB to create legal relations on the basis of the information contained herein. No part of this document may be reproduced, copied or distributed without the prior permission of NAB. All material presented in this document, unless specifically indicated otherwise, is under copyright to NAB.
National Australia Bank trade mark is registered in Australia, Hong Kong, New Zealand, EC, Singapore and the UK (registration applications pending in China, India, Japan and the US).
**Promoted by NAB**
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