Self managed superannuation funds (SMSFs) remain disproportionately underinvested in bonds in general and additionally, of the $630bn in SMSFs as at March 2016, 26% was invested in cash, according to research by the Australian Corporate Bond Company (ACBC).
ACBC brought XTB corporate bond securities to the Australian Securities Exchange (ASX).
With the Reserve Bank of Australia cutting the cash rate from 2% to a record low 1.5% over the course of the past year, such a large proportion of funds allocated to cash could have seen a negative impact.
While the risk of investing in corporate bonds is higher than keeping funds in cash, SMSFs could have invested at yields of up to 5.6% through XTB corporate bond securities in the past 12 months, ACBC data shows.
Bonds are an important asset class that can assist with portfolio diversification.
While corporate bonds were traditionally difficult for individual investors to access, Exchange Traded Bond units (XTBs) are securities traded on the ASX, enabling easy access, transparency and liquidity.
XTBs are backed by the actual bonds and all coupon and principal payments from the bonds flow through to the XTB investor.
Since launching just over a year ago, $100m of XTBs has traded on the ASX.
Corporate bonds can give diversification across companies, sectors, countries and economic cycles.
They are generally negatively correlated to equities, meaning they might assist with risk management by offering a buffer to share price falls.
Bonds can offer coupon payments, providing regular and predictable income in retirement.
Generally, they will offer higher returns than cash deposits and they might help preserve your capital when equity markets are volatile.
ACBC’s research shows that SMSFs own about 16% of the Australian stock market, but those same funds only hold 1% in bonds.
What are the risks?
Corporate bonds can provide a regular income and higher interest rates than what might be available on term deposits, other cash-based products or government bonds, and they carry less risk than shares.
Because you are lending money to the company, you are a creditor, so you stand in front of shareholders for any return if the company goes into voluntary administration. However, there is no guarantee you would get your money back, if that were to occur.
The main risks with corporate bonds is that you might not receive interest payments, or get your money back.
That's 'credit risk' and ways to evaluate it can include:
- checking what country the business might be operating in
- researching demand for the company's products or services
- understanding any cost pressures or competition that the company might have
- reading about the management and the owners to see what they have done in the past and how they are doing now
You can look at the company's performance over time by reading its annual reports and any announcements the company has made on the ASX.
You can find out whether the company's earnings are comfortably larger than the net interest expenses and check what level of debt the company holds.
Researching the company could reveal if it has ever defaulted on any current or previous debt or if there is a significant amount of debt that might be maturing soon.
When you buy or sell corporate bonds, you pay the market price, which can be higher or lower than the face value, and your broker can charge brokerage fees.
If the company that issued the bonds decides to redeem them before they actually mature, this is known as prepayment, or early redemption, risk.
This might happen if interest rates fall and the market price goes up. If this were to happen, you should be paid the face value of the bonds, but you might have paid more than that amount, or they might be worth more on the secondary market.