Invest
What is credit investing and how does it work?
A well-diversified investment portfolio typically includes credit investments to balance risk and return. Here’s what you need to know about credit investing and how it works.
What is credit investing and how does it work?
A well-diversified investment portfolio typically includes credit investments to balance risk and return. Here’s what you need to know about credit investing and how it works.
Credit investing refers to investment in credit or debt instruments – it’s basically what institutional, professional and independent investors do when they include debt securities in their portfolio.
Debt securities can be used as defensive assets to protect your investment portfolio against market volatility and inflation – and you may already be doing it if you’re a bondholder.
Credit investing can be a good way to balance risk in your portfolio, but bonds aren’t the only products you can access.
Here’s what you need to know about credit investments and how it works.
Debt v equity investment
A diversified investment portfolio that is aimed at maximising returns and minimising risk typically includes both debt and equity investments to balance risk and return.
Debt investments function like an IOU because the bond issuer promises bondholders steady interest payments for a fixed period and full payment of the debt upon maturity. Investing in debt securities, such as bonds, is a good way to preserve their capital while earning a fixed income.
Equity investment refers to investments in publicly listed entities or companies whose equity shares are traded in exchanges. The shares investors purchase entitle them to partial or beneficial ownership in the underlying asset.
How debt securities work
Most debt securities work like bonds – with the issuer promising to pay an agreed interest on the borrowed money periodically until maturity when they must pay the face value. However, the income derived from bonds may be greater or lesser than expected depending on the type of interest rate on offer.
- Fixed-rate securities apply the same coupon rate for the entire life of the bond despite market fluctuations. This is the simplest and most common type of bond.
- Floating-rate securities refer to debt securities with coupon rates that move according to benchmark rates, such as the bank bill swap rate. This movement offers protection from the effects of inflation.
- Zero-coupon securities are debt securities that do not pay out the published coupon regularly. Instead, the issuer keeps the expected coupon payments for the duration of the bond and only pays everything – all coupon payments and the face value – upon maturity or redemption.
Note that investors must still pay tax on the coupon each year even if they don’t receive it.
Common types of debt investments
Bonds
Adding bonds to an investment portfolio is a good defensive measure to counter the volatility of equities; however, not all bonds guarantee protection and consistent returns.
- Australian government bonds
Government bonds are debt securities issued by municipal, state and national governments through their respective treasury departments.
Most government bonds are fixed-term fixed-income investment assets, but they are generally safer than other debt securities because the issuers are government entities. - Corporate bonds
A corporate bond is a debt security that corporate entities issue as a way to raise money for their endeavours. Investors who purchase the bond are, in essence, lenders to the issuing companies.
There are different types of corporate bonds with varying conditions and exposure to risk. But while the safety of your money isn’t always guaranteed, corporate bonds often offer higher interest rates – exercise due diligence and choose wisely.
Commercial paper
Commercial paper refers to short-term unsecured debt securities issued by corporate entities that are usually issued at a discount from its face value.
Mortgage-backed security
Mortgage-backed securities (MBS) are similar to bonds, but instead of lending money to government or corporate entities, the investor lends money to home buyers without being the actual lenders.
That is, home buyers still take out home loans from banks and similar lenders, but these lenders pool different home loans together and sell the mortgages at a discount to be packaged as MBS. The MBS are then sold to investors who will receive coupon payments periodically until maturity – similar to bonds.
Distressed debt investing
Distressed debt investing is similar to buying bonds but with a focus on purchasing debt investments that are trading at a significant discount because the underlying entities are at a risk of bankruptcy.
These types of assets are considered below investment grade and are therefore high-risk investments.
Explore nestegg to learn more about investing.
About the author
About the author
Bonds
Sustainable bonds tipped to exceed US$1.5tn in 2022
The sustainable bond market is forecast to grow while overall bond issuance stagnates. ...Read more
Bonds
Corporate bond market review makes 12 recommendations to enhance investment
Twelve recommendations have been made to support the development of a more active corporate bond market in Australia. ...Read more
Bonds
Common mistakes in buying bonds that investors should avoid
The bond market is considered as a safe haven for Aussie investors and it’s easy to see why. ...Read more
Bonds
Student files lawsuit over government bonds
A 23-year-old student has filed a lawsuit against the Australian government after alleging that it failed to disclose climate change-related risks to investors in the country’s sovereign bonds. ...Read more
Bonds
Bonds in the ‘new normal’ – navigating a recession
Dampening downside risk during a global economic downturn requires active management and informed decisions, writes Justin Tyler. ...Read more
Bonds
Buyers beware of silent risks in bond markets
Investors are being urged not to fall into the trap of buying inferior-quality bonds in a low-yielding environment, despite the promises of higher returns, an industry expert has warned. ...Read more
Bonds
Reasons to invest in government bonds
Many investment experts recommend adding government bonds to an investment portfolio in order to reap its benefits while limiting risks and losses. ...Read more
Bonds
Blockchain bond sees $50m boost
The first bond to be created, transferred and managed through its life cycle using blockchain technology has received a new funding boost. ...Read more
Wrapping up an eventful 2021
Listen now
What Omicron means for property, and are units right for first-time buyers? What is equity crowdfunding? Are industry super funds tapping into member funds to save their skins?
Listen now
Will housing affordability improve in 2022? Will buy now, pay later become the norm? Why are Aussies staying in failing super products?
Listen now
Who really benefits from crypto ETFs? How will the RBA respond to rising inflation? Could a mandate help address unpaid super?
Listen now
Bonds
Sustainable bonds tipped to exceed US$1.5tn in 2022
The sustainable bond market is forecast to grow while overall bond issuance stagnates. ...Read more
Bonds
Corporate bond market review makes 12 recommendations to enhance investment
Twelve recommendations have been made to support the development of a more active corporate bond market in Australia. ...Read more
Bonds
Common mistakes in buying bonds that investors should avoid
The bond market is considered as a safe haven for Aussie investors and it’s easy to see why. ...Read more
Bonds
Student files lawsuit over government bonds
A 23-year-old student has filed a lawsuit against the Australian government after alleging that it failed to disclose climate change-related risks to investors in the country’s sovereign bonds. ...Read more
Bonds
Bonds in the ‘new normal’ – navigating a recession
Dampening downside risk during a global economic downturn requires active management and informed decisions, writes Justin Tyler. ...Read more
Bonds
Buyers beware of silent risks in bond markets
Investors are being urged not to fall into the trap of buying inferior-quality bonds in a low-yielding environment, despite the promises of higher returns, an industry expert has warned. ...Read more
Bonds
Reasons to invest in government bonds
Many investment experts recommend adding government bonds to an investment portfolio in order to reap its benefits while limiting risks and losses. ...Read more
Bonds
Blockchain bond sees $50m boost
The first bond to be created, transferred and managed through its life cycle using blockchain technology has received a new funding boost. ...Read more
More articles
Website Notifications
Get notifications in real-time for staying up to date with content that matters to you.
