Do better with bonds

If you want stability and predictability, there are more rewarding places for your funds than term deposits with their woeful returns

Share investors have had a good year in 2017. The ASX All Ords Index climbed 7.32% to 6167.3 in the year to December 22, 2017, after also rising 7% in 2016. But, as some experts warn, it’s probably unrealistic to expect this will be replicated this year. If your share portfolio has performed well it may be time to consider taking some profits and using the funds to diversify.

Fixed-income investing is an area that is often overlooked in this era of historic low interest rates. But there are many more ways to invest in this asset class than just putting your money into term deposits, which are providing woefully low returns.

Bonds are not nearly as familiar to most retail investors as shares, except, of course, for 007! But companies such as fixed-income specialist FIIG Securities (fiig.com.au) and the Australian Bond Exchange (bondexchange.com. au) aim to change that.

When most people think of bonds, they think of government versions but there is also a whole array of corporate bonds, many of which provide returns of over 5%pa. Corporate bonds offer predictable income, capital stability, diversification and the potential to earn better returns, qualities that particularly appeal to retirees or those approaching retirement. They also are flexible as you can buy and sell them when you like. But corporate bonds carry a greater risk of loss of some or all of your capital when compared with bank deposits.

“As a defensive asset, corporate bonds present slightly more risk than bank deposits for slightly higher returns of around 1% to 2% per annum throughout the economic cycle – although there are high-risk corporate bonds earning as much as 12% per annum,” says Elizabeth Moran director of education and research of FIIG Securities.

Including corporate bonds in your portfolio helps you smooth out overall returns over time, especially when markets are stressed or volatile.

How to access bonds

There are several ways you can buy individual corporate bonds or portfolios of bonds. If the ease of buying investments through the ASX appeals to you there are exchange traded products (ETPs) including exchange traded funds (ETFs) that invest in corporate bonds. There are also some ETFs that invest in government bonds. Advantages include a low barrier to entry, at $500, and you buy and sell through your regular broker.

There’s plenty of choice, although nowhere near the overwhelming number of individual stocks. A full list of what’s available is on the ASX website (asx.com.au). There are about 55 single-asset corporate bonds, many issued by major companies including, ANZ, Coca-Cola Amatil, NAB, Qantas, Westpac, Wesfarmers and Woolworths.

And there are about 20 multi-asset Australian fixed-income ETFs, including those that just invest in government bonds, and seven global fixed-income ETFs.

Major issuers include Vanguard, winner of Money’s Best ETF Provider award for 2018, and iShares. iShares Core Composite Bond (ASX: IAF) and Vanguard Australian Fixed Interest (VAF) were joint winners of the Best Income ETF category in Money’s 2018 Best of the Best awards. Both invest in quality AAA and AA Australian government and semi-government bonds.

Both also have funds that cover corporate bonds. For example, the iShares Global High Yield Bond (AUD Hedged) ETF (IHHY) aims to provide investors with the performance of an index composed of liquid, global developed, high yield corporate bonds (hedged to Australian dollars). It returned 8.99% in the year to November 2017.

The Vanguard Australian Corporate Fixed Interest Index ETF (VACF) provides investors with low-cost, diversified exposure to Australian corporate bonds. It returned 5.08% in the year to November.

You can find information on ETFs, including fixed-income specialists, on the Morningstar website (morningstar. com.au). Some research is available at no cost but if you want more detail you’ll need to subscribe.

There are also some listed investment trusts (LITs) that invest in fixed income. The latest to list is the MCP Master Income Trust (MXT), which provides investors with direct exposure to the Australian corporate loan market, a market that has been largely inaccessible to retail investors. Its target return is the Reserve Bank cash rate plus 3.25%pa net of fees (currently 4.75%), with distributions paid monthly.

Managed funds

There is an array of managed funds investing in both local and global fixed income. Morningstar, which also researches these, lists 70 Australian bond funds requiring a minimum investment of $50,000 or less. Over 10 years the PIMCO Wholesale Australian Bond fund has returned 7.03% a year, ranking it first for that period. The fund, which also won Money’s Best Australian Fixed-Interest Fund category for the past three years, requires a $20,000 minimum investment.

There are 43 global fixed-income funds requiring a minimum investment of $50,000 or less on Morningstar’s database. Another PIMCO fund, Global RealReturn Wholesale, is the pest performer over 10 years, showing a return of 8.19% a year. Minimum investment is $20,000.

Morningstar also details 52 diversified bond funds, 10 emerging market bond funds and six inflation-linked bond funds.

Some managed funds also have mFund versions – there are 36 fixed income mFunds – which can be bought through most brokers, including online. This means you don’t have to fill out the paperwork to join a managed fund, which some investors find tedious.

Portfolio building

FIIG provides a free weekly newsletter The Wire, written by Moran, which tells you about new issues, research and recommendations. In November FIIG provided sample portfolios based on investing $250,000. The higher yield corporate bond portfolio was returning 5.87% and its investment grade corporate bond portfolio was returning 4.3%.

The specialist offers an array of services for private investors including its DirectBonds Service, which offers more than 300 bonds, a mix of fixed, floating and inflation-linked. You can choose from sample portfolios or select the bonds to suit your individual investment needs. You can buy and sell bonds in parcels from $10,000 with a minimum portfolio balance of $250,000.

FIIG’s Managed Income Portfolio Service (“MIPS”) enables investors to combine the benefits of directly owning fixed-income securities with the expertise of a professional investment management team. The minimum investment amount for MIPS is $250,000 for each investment program, or $5 million for a customised program. There are three options. At the time of writing Conservative Income was providing a gross yield of 4.11% to maturity, Core Income a return of 4.12% and Income Plus, which carries moderate risk, 5.77%.

The Australian Bond Exchange enables self-directed investors to access the Australian corporate bond market directly, meaning you don’t need to go through third-party funds or institutions. You own the bond and receive the full coupon with no hidden fees or charges.