Source: OECD Pensions in Focus 2018

Key features bonds provide

1. Income stream

Bonds provide income from regular quarterly or half-yearly coupon payments, paid on set dates. This allows investors to choose specific bonds with coupon dates aligned to known outgoings.

Bonds also have fixed maturity dates when the principal amount or face value is repaid. Bond investors know when they will receive the face value of the bond back to either spend, or re-invest.

2. Capital preservation

At maturity the bond face value is returned to the investor. This makes a bond an effective capital preservation tool – assuming the issuer doesn’t default.

3. Diversification of returns

Bonds usually have low or negative correlations to equities, and a different risk/return profile.  All investments carry risks, but as the potential upside of shares is higher than bonds, the same is true of the potential downside.  The worst year for shares was -38% in 2008, yet for bonds was-5% in 1994. (Source: Bloomberg)

Portfolio protection in uncertain times

Investment-grade bonds are a defensive asset class. They offer stability and diversification in a portfolio.2018 was a bumpy year for shares, but so far 2019 has seen shares rebound. The question is where to from here?

When the share market seems to be going up and up, it’s easy to overlook the cushioning effect of fixed income. But, in volatile times it’s increasingly important to ensure you protect the wealth you’ve built up. Investors with balanced portfolios (50:50 bonds and shares), may find that in times of equity market stress, their bond returns can balance their losses.

Shares and bonds are complementary and necessary parts of a well-diversified portfolio

Total Returns Equities vs Bonds: 1 Jan 2018 to 31 Mar 2019

Source: Bloomberg & XTB

Bond coupons are fixed, share dividends are not
AMP, BHP and Telstra made cuts (and some hikes) to dividend payments over the last year or so. No one complains when a dividend is hiked, but cuts are harder to swallow. Dividends are paid at the discretion of the company, and are declared shortly before payment. In contrast, bond coupon payments are a legal obligation, decided when the bond is issued.

“Until recently I was invested 100% in shares. However, I knew I wanted to protect what I’d made and fixed income was the way to do this.” Retired, retail XTB investor

Risks to be aware of
As with all investments, there are risks. With higher yield comes higher risk, whichever asset class you are looking at. Much of the risk from owning bonds is driven by:

1. Time to maturity and
2. Credit quality of the issuer.

Focusing on investment-grade issuers, can minimise the potential of a default. The global default rate for 3-year Investment Grade bonds is 0.43%, but over 10% for Speculative Grade.

Choices for bond returns on ASX
A broad range of ETFs, mFunds and close to 50 individual Exchange-Traded Bond units (XTBs) provide access to bond returns on ASX.

Bond ETFs and funds offer a diverse range of bonds within one transaction. They’ve helped open up this asset class and offer a simple way to buy and sell via ASX. But, there is a key consideration for investors – the‘fixed income’ gets lost in bond funds and ETFs

Being continual, ETFs don’t have an end date, therefore they can’t offer investors a predictable return BEFORE they invest. And, that benefit of diversification, with bonds added or removed sometimes daily, has the downside for investors of not knowing what either your income or your return will be.

Remember - knowing your cash flow BEFORE you invest is at the heart of fixed income.

Keep your fixed income predictability

XTBs offer a different, more predictable solution. Each XTB ‘mirrors’ the cash flow of a single, specific bond issued by one company. So, each XTBprovides two known features:

1. A Coupon Amount and Payment Schedule; and
2. A Maturity Date.

For investors with little or no exposure to bonds, who want a broad exposure to fixed income, the range of ETFs or mFundsis worth consideration. However, for investors who want a predictable investment, knowing when you’ll receive income, when your investment matures and what your return is before you invest, XTBs could be a better fit.

If you already have a bond ETF, adding one or two XTBs could provide a complementary element of predictability. Find out more in “AnInvestor’s Guide to Fixed Income”.

¹ATO SMSF data

Disclaimer

The information in this article is general in nature. It should not be the sole source of information. It does not take into account the investment objectives or circumstances of any particular investor. You should read the PDS that relates to that Class of XTB prior to making an investment decision and consider, with or without advice from a professional adviser, whether an investment is appropriate to your circumstances. Australian Corporate Bond Company Limited is the Securities Manager of XTBs and will earn fees in connection with an investment in XTBs.