Lifting the lid on corporate bonds

According to Bloomberg, there’s more than $600b in corporate bonds (including mortgage-backed issuance) outstanding in Australia — that’s around 30% of the size of the ASX. With the current instability in global economies, the ongoing threat of an all-out trade war between the US and China, and the recent volatility in equity and property markets, now is the time to take a closer look at the benefits of owning corporate bonds.

Despite the Australian corporate bond market almost doubling over the past decade, direct investment by Australians is relatively low compared to other countries. In fact, private investors hold less than 1%[1] of all corporate bonds on issue in Australia, suggesting the Australian market has a way to go.

Understanding the basics

As a fixed income asset, corporate bonds are a defensive investment with low correlation to growth assets, making them an important addition to any diversified portfolio, particularly for those transitioning to retirement or in retirement. In Australia, corporate bonds are issued by banks and other non-financial institutions (typically large companies) to raise funds to finance their operations, investments, or debt financing.

Traditionally corporate bonds were only held by institutional investors or foreign investors, driven in part by a lack of awareness of the benefits to private investors and partly by the fact that bonds could only be traded in parcels of $500,000 or more. But this trend is changing with the introduction of small parcel bonds, which allow private investors to access the benefits of corporate bonds without the high barrier to entry.

A regular and reliable source of income

One of the benefits of fixed income investments is the regular income. Corporate bonds not only provide this regular income in the form of coupon payments (either a fixed or floating rate), but if held to maturity the investor also receives the face value of the bond.

Corporate bond issuers are contractually obliged to pay these coupon payments no matter how the company performs. Compare this to a shareholder in a company whose dividend income is at the discretion of the company depending on performance. A corporate bond investor is deemed to be a ‘creditor’, so in the event that the issuer goes out of business, the investor should receive their interest payments and principal invested before distributions are made to other corporate investors, such as shareholders.

“There are two main concerns for corporate bond investors: (i). Will the company pay the investor a regular coupon and, (ii). will the investor get their money back,” said Mark Philips, Dealer in corporate bonds at RIM Securities. “We offer wholesale investors access to good company credit that pays a regular coupon and the investor’s money back at maturity, and we can do it on a regular basis.”

Risk vs reward

Corporate bonds are deemed to be riskier than other forms of fixed income investments, for example government bonds or term deposits, due to the additional risks associated with the corporate issuers, such as the business failing. However, they do offer a higher yield to compensate for that higher risk.

This higher yield is an important consideration for retirees who no longer rely on employment income but are seeking a less risker asset than equities. Furthermore, bond returns are typically less volatile than other growth assets due to the greater certainty around their income flows and performance.

Like any investment, managing risk is important. “At RIM Securities, we don’t originate debt — we provide our clients access to existing bonds and opportunities to take up offerings into new bonds as they arise in the primary market. Through our daily dealings in the secondary market, providing access to existing bonds, we get a good idea of liquidity as well as pricing. One of our criteria we insist on is that the company’s balance sheet exceeds $300m before we consider it,” said Mark.

Diversification where it counts

A well-diversified portfolio exhibits low volatility thanks to the spread of different asset classes and subsequent exposure to risk. Given their yields and risk profile, corporate bonds sit somewhere in the middle of lower-risk fixed income assets and higher-risk growth assets, such as shares and property. And because they are a defensive asset, they help protect the portfolio from volatility.

“One of the advantages of buying and selling bonds with RIM Securities via Cashwerkz is that you’re not limited to investing only in banks. Investors can access the strength and balance sheet of strong companies too”, explains Mark. This is important as it helps minimise the exposure to a single sector.

Preserving what’s important

Capital preservation should be a top priority for any investor, especially those close to or in retirement, and this is one of the strengths of corporate bonds. Given their structure, corporate bonds provide relative certainty in terms of an investor retaining their original capital if held to maturity.

Accessing corporate bonds via the RIM Securities Small Parcel Bond Service

Your wholesale and sophisticated investors can now access the unlisted Australian and international corporate bond market with a minimum investment of $50,000.

But why use the RIM Securities Small Parcel Bond Service?

With a strong pedigree in bond investing spanning more than 15 years, RIM Securities identifies high-quality primary and secondary market bonds offered by large companies, financial institutions and institutional mandates. It then ‘slices down’ the bond into smaller investments. “This allows wholesale investors to access institutional-style investments for a smaller outlay, such as $50,000,” explains Mark. “We also build up our own inventory and this means investors can buy and sell their bond investments through us, so they don’t need to hold the bond to maturity if it doesn’t suit their strategy.”

RIM Securities Small Parcel Bond Service: benefits at a glance

  • Direct access to unlisted bonds that complement other income-focused investments
  • Par value back at maturity
  • Beneficial ownership so you can sell bonds when it suits your strategy, or hold the bond to maturity
  • Receive any tax benefits when selling the bond
  • Known and regular income

If you’d like to know more about the RIM Securities Small Parcel Bond Service, register your interest here, or call Mark Phillips at RIM Securities on 07 3020 3000.

[1] Ownership of Australian Equities and Corporate Bonds, RBA September quarter 2010

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