Corporate bonds part of a balanced portfolio
Stocks may grab all the headlines, but they’re not the only way to invest in companies.
Corporate bonds should also be part of a balanced portfolio, yet they remain overlooked by many Canadian investors. Here’s a basic primer to get you familiar with this important asset class.
Corporate bonds are issued from companies that are familiar to most Canadians, such as Royal Bank of Canada, The TorontoDominion Bank, Canadian Tire, Transcanada Pipelines, General Electric, Loblaw and Telus, just to name a few. Unlike stocks, bonds do not give investors ownership interest in the issuing company. Instead, they are debt instruments that are considered financial obligations.
Each bond sold — and they are usually issued in denominations of $1,000 — comes with a maturity date. At maturity, which can be anywhere from a few years away to 30 years or more into the future, the company is to reimburse the investor for the sum provided. In between the date of purchase of the bond and its maturity date, the investor is typically paid semi-annual interest, though interest payments can also be made on an annual, quarterly or monthly basis. This steady stream of income can make corporate bonds an attractive fixed-income vehicle for everyday expenses.
A bond’s yield to maturity is the accumulation of that interest plus any profit (or loss) that is recorded on its maturation date. Generally speaking, the value of corporate bonds decreases as interest rates increase, and vice versa.
All companies that issue bonds are analyzed by ratings agencies, such as Standard & Poor’s and DBRS. These agencies assign credit ratings, which are based on a company’s financial strength, future prospects and past history. For bonds to be known as “investment grade,” they must be rated “BBB” or higher. If the rating is lower than BBB-, they are considered “noninvestment grade” — often referred to as “high yield” or “junk” bonds. These are riskier investments because the company is deemed to have a more uncertain ability to repay the interest or principal on its debt obligations.
It’s always important to carefully assess the risks of corporate bonds. The ultimate risk relates to a company going out of business. If that were to happen, you could lose your investment. In addition, risk comes with credit rating changes.
If you buy a bond from a company, and its credit ratings are downgraded, the value of your bond could decrease because investors will expect a higher level of compensation for the greater risk. That’s why you should stick with investmentgrade quality bonds from a vari- ety of issuers in different sectors. Diversification in owning more than one issuer is important.
Corporate bonds often provide higher rates than other fixed-income instruments such as government or provincial bonds. But like government bonds, corporate bonds of the same credit quality with the longest terms generally offer the highest rates, to compensate for increased uncertainty over an extended time.
Corporate bonds are also interesting because they can have certain features, such as the call feature, which is the right of the company to buy back the bonds prior to maturation at par.