Did you know that in addition to issuing shares on the stock market, famous Australian companies like Qantas, Wesfarmers, and Woolworths also issue corporate bonds?
Corporate bonds are a form of debt security that enables companies to borrow money from investors in exchange for regular interest payments and the repayment of principal at a fixed date. They are one of the main types of investments within the broader fixed income category, with the other being government bonds.
Purchasing corporate bonds can be thought of as providing a loan to a company seeking to borrow money for expansion. For example, you could invest $1,000 in corporate bonds and receive 5% annual interest over 10 years. After 10 years, the company will repay the original $1,000, but you would have earned $500 in interest along the way.
Four reasons to consider corporate bonds in a portfolio
The argument for investing in corporate bonds is based on the characteristics that distinguish them from shares and government bonds. Let’s examine some of these key differences.
- Certainty over principal repayments
Like government debt, corporate bonds have a predetermined “maturity” date where the issuer must repay the principal, while a company that issues shares never needs to repay the capital. Maturity dates range from one to 30 years.
- Predictable interest payments
Corporate bonds are an effective option for investors seeking to establish predictable income streams and have certainty about future cashflows as they offer a set schedule of either:
- Fixed payments – For example, 5% annually
- Floating rate structures – For example, 2% above a specified reference rate (adjusted regularly)
A company is considered to be in default if it misses a single payment on a bond. Meanwhile, stock dividends are completely optional and up to the discretion of a company’s board, making it challenging to predict future income.
- Corporate bonds take priority in bankruptcy
In terms of their priority, in the event that a company goes bankrupt, corporate bonds are considered to be safer than shares. This is because bondholders are prioritised above shareholders in a company’s capital structure during bankruptcy.
- Higher yields than government debt
Corporate bonds tend to offer higher yields than government bonds because they are generally considered to be a higher risk investment. This is because there is a greater likelihood that a company may default on its bond payments compared to a government, which has the ability to raise taxes or print more money to meet its financial obligations.
How are corporate bonds priced?
When a company is issuing corporate bonds, the interest rate is determined by factors such as current interest rates and investor demand.
After the bond is issued, the price may fluctuate like stock prices. But corporate bond prices are typically less volatile than shares and are – to an extent – anchored to their face value, which is usually $100 in Australia.
Bond prices are affected by factors including evolving perceptions of an issuer’s creditworthiness and central bank interest rates. After the bond is issued, it may trade at a premium or discount to face value until maturity. These changes will impact the yield received depending on if an investor buys the bond higher or lower than its face value.
|Recommended reading: Learn more about the different yield measures applied to fixed income securities and how to interpret them in this blog.|
How to access corporate bonds on the ASX
Historically, Australian investors have faced challenges in accessing corporate bonds. They are often traded between large institutions without ever being offered to everyday investors
However, exchange-traded funds (ETFs) are helping democratise investing in the Australian fixed income market.
Today, a number of corporate bond ETFs exist on the ASX and these offer several benefits including
- Diversification: Corporate bond ETFs allow investors to diversify their bond portfolio across a range of issuers.
- Access: ETFs trade on an exchange, making it easy for investors to buy and sell their holdings.
- Regular income: Some corporate bond ETFs pay out interest monthly, providing regular cashflow to investors, with the option to reinvest their income.
What are the risks of corporate bonds?
It’s important to be aware of the risks involved when investing in corporate bonds. These include:
- Default risk: The possibility that an issuer may not be able to make interest or principal payments as promised.
- Interest rate risk: Bond prices can be sensitive to changes in interest rates, particularly for bonds that are not due to be repaid for many years.
- Credit spread risk: In times of economic stress, the difference between the yield in corporate bonds and government debt may widen, leading to a decline in the value of corporate bonds relative to government bonds.
Specifically with fixed income ETFs, it’s important to keep in mind that bonds in ETF portfolios are continuously being added or removed due to securities reaching maturity and changes in the index. As a result, bond ETFs do not have a set maturity date, unlike individual bonds.
What are credit ratings?
In the same way that people have their own credit scores, corporations and governments have their credit ratings assessed by Standard & Poor’s, Fitch Ratings and Moody’s.
They classify bonds as either:
- Investment-grade: Often scored between “AAA” to “BBB”, depending on the agency
- Non-investment-grade: Also known as “high yield” or “junk” bonds, they are typically defined as those with a BB rating or lower
Credit ratings are important to consider when evaluating the risk of a particular bond or bond portfolio. Fixed income ETFs usually disclose the weighted average credit rating of underlying bonds held.
How to invest in corporate bonds
Betashares offers a range of fixed income funds that invest in corporate bonds, providing a simple and cost-effective way to add this asset class to your investment portfolio.
As with all you can buy or sell units on the ASX using an online brokerage account or through a financial adviser, just like you’d buy or sell any share on the ASX.
This information has been prepared by Betashares Capital Limited (ABN 78 139 566 868, AFSL 341181) (“Betashares”). This information is general only, is not personal financial advice, and is not a recommendation to buy, hold or sell any investment or adopt any particular investment strategy. It does not take into account any person’s financial objectives, situation or needs. Before making a decision to invest in any Betashares Fund you should obtain and read a copy of the relevant PDS available from www.betashares.com.au or by calling 1300 487 577 and obtain financial advice in light of your individual circumstances. You may also wish to consider the relevant Target Market Determination (TMD) which sets out the class of consumers that comprise the target market for the Betashares Fund and is available at www.betashares.com.au/target-market-determinations. To the extent permitted by law Betashares accepts no liability for any loss from reliance on this information.
For more information on risks and other features of these funds, please see the Product Disclosure Statement and Target Market Determination available on this website.
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