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How to get started in bonds

This article appeared in the March 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Why share investors should learn more about interest rate securities.

Photo of Tony Hunter By Tony Hunter, ASX

Australian investors love their shares. They love the capital gain when the market is roaring and the franked dividends. But they don't like it when the value of their investments falls, and as they get older, certainty of income becomes increasingly important.

Given all this, it would seem that a balanced approach to investing is appropriate: some equities exposure, some fixed interest, with the proportions varying according to circumstances. But this has not been the way it has panned out.

If you have watched old American movies you might have heard people, usually wealthy, talking about buying bonds or having a large bond portfolio. Rarely did you hear them talk about shares. This was because investing in bonds was regarded as the core holding.

But Australians' love of shares, combined with a relatively smaller pool of fixed interest choices, means that not enough investors adopt this dual approach. Ken Henry (ASX non-executive director and former Treasury secretary) and David Murray (former Future Fund Chairman) have both spoken publicly on this equities love affair and argued that bonds should be a core holding for superannuation because they reduce the volatility of the portfolio.

Building a culture of fixed-interest investing

Many investors do not know much about investing in fixed interest and advisers often have much stronger expertise in equities. Why? Not enough fixed-interest products and a lack of client interest. But that is changing.

A range of fixed interest securities were issued after the GFC, largely because of the difficulty in getting bank funding. Investors became more risk-averse and looked for a safe haven. Some went to term deposits while others sought higher returns (for a higher risk) via corporate bonds. Others sought some equity exposure as well a reliable return, so were attracted to the hybrids coming on the market.

Increased supply and demand resulted in a much more vibrant interest-rate securities market. A broader market and people taking an interest in diversifying their portfolio is a good thing. But investing in interest rate securities is not the same as investing in shares.

Here are a few examples why:

  • Different interest rate securities carry different risks and risk can vary from issuer to issuer
  • Not all instruments have the same level of security; there is secured debt and unsecured debt
  • You could still lose money on a fixed-interest investment if you bought at one price and then sold at a lower price
  • You could still lose money if you bought a bond at above face value and then held the bond to maturity, where you would receive face value on redemption
  • Bonds will have varying sensitivity to interest rates depending on how long they have until maturity.

Perhaps the biggest challenge is understanding bond pricing, because it can seem counter-intuitive. If interest rates go up, the price of bonds goes down, and vice versa. Bond pricing can be a complex topic, but fortunately there are tools to help you calculate prices.

Another thing to consider is that although bonds are issued with a coupon (think of it as their interest rate), that is not how you should compare bonds. You should compare their yield to maturity, which factors in the income you can expect to earn from when you bought the bond to its maturity plus any capital gain/loss you would incur.

You can see that bonds and shares are quite different beasts, which is why many investors and advisers shy away. Yet, diversification across asset classes and within asset classes is widely accepted as a prudent strategy. Although some people might believe now is the time to scale back cash/fixed interest exposure and increase equities, this does not mean even equities bulls should ignore this asset class.

Educate yourself

Just as low-risk instruments with reliable yields can be regarded as the stumps of your investment house, education can be the foundation for implementing your investment strategy.

ASX has a range of education resources, all free. You can read a booklet, do a course or watch an industry expert's talk. All things about interest rate securities can be accessed from the ASX website.

Booklet

You might prefer to print out a document to read at your leisure. Understanding ASX Interest Rate Securities (PDF 583KB) provides a good overview of the range of products available for investing via ASX, as well as their key risks and benefits.

Online course

The ASX online courses are free and do not require registration. They are self-directed; you can choose which topic you want to look at in the order that suits you. There are interactive exercises and quizzes to reinforce your learning, and you can print the course notes. The Interest rate securities course covers corporate bonds as well as hybrids and convertible notes.

What's available to trade?

Find a full list of interest rate securities on offer via ASX and if you want an overview of how trading in interest rate securities has been going, or what has been recently listed, you might find the monthly update report useful.

Australian Government Bonds

Investors will soon be able to obtain Exchange-Traded Australian Government Bonds, and there is free ASX online course dedicated to them.

My message now is that interest rate securities are investment products that all investors and advisers should take an interest in. Even experienced share investors should not assume their knowledge and experience is enough to start investing in interest rate securities.

Look at the range of free education resources ASX has developed and consider what role interest rate securities should play in your portfolio.

About the author

Tony Hunter is head of ASX Education.


The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2014 ASX Limited ABN 98 008 624 691. All rights reserved 2014.

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