Investing in corporate fixed-income securities like bonds and market-linked notes can be a popular strategy for investors looking to boost their income. However, with such a large universe of investment options available, it can be challenging for investors to decide which securities to include in their portfolio.
As a result, some investors simply opt for a bond fund which provides exposure to a basket of underlying securities. While this can help boost portfolio diversification, it can also dilute investment performance due to underperforming securities dragging on overall returns.
While some bond funds passively track an index, other funds are actively managed, leveraging the skills and expertise of investment specialists which can be particularly beneficial when navigating some of the riskier segments of the fixed-income market.
Costs and Expected Returns
While passive funds are generally inexpensive, management and performance fees for actively traded funds can be substantial. Additionally, there is also no guarantee an investment manager will be able to meet their return targets.
In contrast, when investing in individual fixed-income securities, a commission is usually charged when the security is purchased, and unless it’s sold prior to maturity, there are usually no other fees. This means there is less ambiguity regarding costs, and investors can also obtain a clearer view of their expected returns from the outset given individual securities pay out a defined amount of income (known as coupon payments) at regular intervals as well as a return of the (known) face value at maturity.
Bond funds will typically distribute based on the interest income generated by the underlying securities (and therefore may vary substantially from payment to payment), making it more challenging to budget and plan for regular cash flow needs.
Varying Degrees of Customisation
As mentioned, investing in a bond fund provides exposure to a selection of fixed-income securities which are determined by the investment manager in accordance with the ‘investment mandate’ of the fund (details of which should be set out in the disclosure document for the Fund). While this can take some of the stress and hassle away by removing the need for security selection, it can also mean investors have less control over returns, fees and charges.
For example, sometimes a fund will need to sell some of its holdings to meet redemptions, resulting in capital losses for all investors, regardless of whether they wanted to sell or not.
By investing directly into individual securities, investors can hand-pick investments which best align with their financial goals and risk tolerance. From credit quality, issuer-type, and coupon rates, all of these variables can be controlled with a direct investment approach.
Mitigating Interest Rate Risk
Interest rate risk is a significant concern for fixed-income investors as when interest rates rise, the price of securities typically fall, negatively impacting the value of investment portfolios.
With a bond fund, investors can sustain permanent loss of capital given they frequently buy and sell bonds, whereas with direct investment, there is the option to hold securities until maturity. Assuming the issuer of the security does not default, an investor will receive the face value of the security back, regardless of fluctuations in interest rates and volatility in the market.
Making a Decision
When considering corporate fixed-income investments, there are various aspects to be aware of. While bond funds can be a convenient way to gain exposure to a diversified portfolio of bonds, investing directly in corporate bonds offers several compelling advantages.
From greater control and customisation to the ability to better manage interest rate risk, direct investment into corporate bonds can be an attractive proposition when compared to investing in a bond fund.
While the security selection process of direct investment can be daunting, the Australian Bond Exchange has a defined product suite of high quality fixed-income investments. All the securities we offer have undergone an extensive and rigorous product approval process.
For more information about our suite of available fixed-income investment opportunities, contact an ABE adviser today.
Before you Go…
Last week we announced our latest exclusive market linked security for leading U.S, department store and retailer, Macy’s Inc, offering a 7.25% pa return paid quarterly over a 4 year term.
As one of America’s largest retailers, Macy’s operates approximately 725 stores across some 45 US states and is a global household name with a listed market capitalisation of USD $3 billion.
With consumer spending in the U.S. still very strong, we believe Macy’s is well positioned to continue delivering attractive returns into the future.
Disclaimer: Australian Bond Exchange Pty Ltd ACN 605 038 935 AFSL 484453 (ABE). This article is intended to provide general information of an educational nature only. It does not constitute the provision of personal advice and does not take into account your personal objectives, financial situation or needs. Before investing with ABE, you should consider the appropriateness of the investment to your particular financial and taxation situation and consider obtaining independent advice before making an investment. Examples in this article are for illustration purposes only and are not a recommendation to buy, sell or hold a particular investment. ABE makes no representation or guarantee as to the availability of a bond with the characteristics described in this article or that an investment made by you will generate the returns in the illustration. Past performance is not an indication of future performance. Investing with ABE is subject to our Client Services and Custody Agreement Terms and Conditions and Financial Services Guide.