Corporate bonds - the reliable, quiet achiever

I imagine it’s quite hard to do. They put their trust in you, pay you a fee and your strategy fails to deliver. Aside from the obvious risk of losing clients to other practices, you put your client’s lifestyle at risk.

Why invest in bonds?

Direct investment in corporate bonds will help you deliver consistent income and the capital stability for which many SMSFs are looking. They are one of the few investments that define income up front and lock in future cashflows, critical for SMSFs in drawdown.

One of the great features of corporate bonds is the diversification they bring to a portfolio. They are typically defensive, low risk investments that diversify away from growth assets such as shares and property. Importantly, they pay higher returns than term deposits for slightly higher risk.

Many large international companies issue bonds in the Australian corporate bond market. For example, Apple, General Electric, BMW and SAB Miller all issue Australian dollar denominated bonds. Australian joint venture entities, including some public private partnerships (PPPs) not listed on the ASX also issue bonds linked to infrastructure assets.

If you have clients with USD or euros earning meagre returns in deposit accounts, another option is foreign currency bonds.

Returns available for corporate bonds

Not long ago, you could allocate a client’s whole defensive portion of the portfolio to deposits, but that no longer works. With returns under 3 per cent, the income just isn’t enough.

Corporate bonds will earn between 1 and 2 per cent per annum more than term deposits throughout the economic cycle. At the moment, returns are between 3.75 per cent and 5.5 per cent for a low risk investment grade bond portfolio.

Investors prepared to take on more risk can earn higher returns by incorporating high yield bonds, which can yield 6 to 12 per cent per annum. One strategy we would commonly suggest is that clients invest 70 to 80 per cent in low risk investment grade bonds, then the other 20 to 30 per cent in many high yield bonds to diversify risk.

Surprisingly, over the last ten years the AusBond Corporate Bond Index has outperformed the ASX Accumulation Index returning 7.21 per cent versus 5.48 per cent to the end of September 2016.

How much should clients invest?

While clients are young, they should predominantly invest in growth assets such as shares and property. However, as they approach retirement their portfolio allocation should change and become more defensive. We would suggest their portfolios are split 50/50 between growth and defensive assets. That is because they don’t have the time to recoup any funds lost due to a major event, such as the global financial crisis.

Once in drawdown, we think clients should be even more defensive to help preserve capital and ensure a comfortable lifestyle. One old rule of thumb is to own your age in bonds.

Young people also invest in corporate bonds; think of world famous sports people. The main aim for these investors is to preserve capital and make it last. Astute advisers suggest a big chunk into corporate bonds.

Four ways to invest in bonds

How you invest in bonds will depend on the time you and your clients have and the amount of money you have to invest. For absolute control, investing direct in the over-the-counter market is the optimum.

There are four ways to invest in bonds:

1. Managed funds

• Great for diversification and for investors with smaller amounts;
• Need to have a certain percentage invested in government bonds for liquidity, which pay very low returns and are highly priced at this point in the economic cycle – a negative;
• Range of funds that can be active or passive;
• High fees for active funds can wipe out returns in a low interest rate environment; and
• No maturity date.

2. Exchange traded funds (ETFs)

• Easy to access and low amounts needed to invest;
• Growing global government debt (bonds) take up bigger percentages of the indices – building risk when market commentators are calling for lower allocations to government bonds;
• We expect returns to decline over time and movements in government bonds yields need to be watched – these are not set and forget investments; and
• No maturity date.

3. ASX – government bonds and XTBs

• Small investment amounts; and
• Lacks diversity – very small number of overall securities – no inflation linked or foreign currency bonds.

4. Direct investment - two options

• DirectBond Service - Over 300 bonds available from $10,000 denominations, minimum initial investment $50,000. Includes fixed, floating and inflation linked bonds, high yield and foreign currency; and
• Individually Managed Account – Our expert portfolio manager invests on the client’s behalf subject to one of four mandates. Flagship ‘Income Plus’ option annualised net return for the six months until 30 September 2016 was a very impressive 7.43 per cent.

Direct bond investment into either of the above are on many platforms including: SuperIQ, Class, Praemium and IRESS for ease of reporting. Clients can also access daily prices and are sent monthly statements.

Elizabeth Moran, director, client education and research, FIIG