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How your SMSF can invest in corporate bonds on the ASX

How your SMSF can invest in corporate bonds on the ASX

Equities have long been the preferred investment for SMSFs, but corporate bonds are an investment tool that trustees might be wise to consider in the current low interest rate environment.

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.

Most corporate bonds are debentures, meaning they are not secured by collateral. Investors of such bonds must assume not only interest rate risk but also credit risk, the chance that the corporate issuer will default on its debt obligations. This article is intended to provide general information of an educational nature only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Investors should consult a range of resources, and if necessary, seek professional advice, before making investment decisions in regard to their objectives, financial and taxation situations and needs because these have not been taken into account. Any securities or prices used in the examples given are for illustrative purposes only and should not be considered as a recommendation to buy, sell or hold. Past performance is not indicative of future performance. Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (CommSec) is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 and a Participant of the ASX Group and Chi-X Australia. While potential SMSF investments have been illustrated within this content they do not represent a comprehensive suite of possible investment products and services within the guidelines pursuant to the SIS Act 1993 with ATO oversight.