Why invest in bonds?

Bonds can play several key roles in an investment portfolio, providing diversification, stability and income.

• Steady income stream: investment bonds can provide a steady stream of income through regular interest payments paid on a quarterly, half-yearly or annual basis. This can be attractive if you’re seeking a reliable source of cash flow
• Diversification: investment bonds provide a buffer during periods of sharemarket volatility - when share prices are falling, bond prices may not be affected in the same way. Including bonds in your investment portfolio can therefore help to reduce risk
• Capital preservation: Unlike shares, investment bonds have a fixed maturity date where the issuer repays the principal amount you invested. This can be appealing if you prioritise the return of your initial investment
• Reduced volatility: for retirees or those approaching retirement, bonds can provide a more stable investment option, helping to preserve capital and reduce exposure to the potentially higher volatility of shares
• Protection against rising interest rates: certain types of bonds, like inflation-protected bonds, can provide protection against rising interest rates. This can be valuable in times when interest rates are expected to increase.
   

What are the risks of investing in bonds?

Just like all kinds of investments, investing in bonds does carry some risks. Here are some of the most common:

Liquidity risk: Some bonds may be less liquid, meaning it can be challenging to sell them quickly without impacting the price. So, if you need to sell a less liquid bond in a hurry, you might have to accept a lower price

Interest rate risk: The value of existing bonds can fluctuate based on changes in interest rates. When interest rates rise, the market value of existing bonds tends to fall, and vice versa. If you need to sell a bond before it matures when interest rates are higher, you may experience a loss

Credit or default risk: An issuer of your bond may be unable to make interest payments or return the principal amount at maturity. If the issuer defaults, you may lose part or all of your investment

Market risk: General market conditions, economic events, or global crises can impact bond prices. Bond values can therefore be influenced by broader market movements which can affect returns

Inflation risk: Inflation erodes the purchasing power of money over time. Fixed-interest payments may not keep pace with inflation. If inflation rises more than expected, the real (inflation-adjusted) return on bonds may be lower than anticipated.
 

Why are investment bond prices affected by rising interest rates?

When interest rates go up, the prices of investment bonds typically fall. This happens because higher interest rates make newly issued bonds more attractive with better returns. Existing bonds, offering lower fixed interest rates, become less appealing in comparison.

Additionally, there is an inverse relationship between investment bond prices and yields (interest rates). Investors demand higher yields when rates rise, leading to a willingness to pay less for existing bonds.

The sensitivity of investment bond prices to interest rate changes, inflation concerns, and market expectations also contribute to the impact of rising interest rates on bond prices.
 

How does MLC gain access to investment bonds?

The primary issuers of investment bonds in Australia are governments and companies. Investors can gain access to unlisted bonds through several channels, including:

• Australian Government Bonds (AGBs) represent sovereign debt issued by the Federal Government. The bonds typically guarantee a rate of return if held until maturity and can be bought on the Australian Securities Exchange (ASX) at market value with a brokerage fee incurred.

• The Federal Government also issues inflation-linked or indexed bonds with coupon payments and the face value of the bonds increasing in-line with changes in the Consumer Price index (CPI).

• Semi-Government bonds (semis) are semi-sovereign debt issued by Australian states and territories, bought and sold through treasury corporations.

• Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market. The minimum amount required to trade is typically up to $500,000. As with government bonds, investors will recoup the face value of the corporate bond at maturity unless the issuer defaults. But investors should consider the credit risk of corporate bonds before they buy, while consulting the issuer’s prospectus and product disclosure statement (PDS).

• Investors can also gain access to ASX-listed Exchange Traded Bonds (XTBs).
   

Frequently Asked Questions about investment bonds

What determines investment bond prices?

Investment bond prices are influenced by factors such as changes in interest rates, credit risk, market conditions, and the time remaining until the bond matures.

What is the maturity of a bond?

Maturity is the date when the issuer repays the principal amount to the bondholder. It marks the end of the bond's term.

What’s the difference between government and corporate bonds?

Government bonds are issued by governments, considered low-risk, and often have lower interest rates. Corporate bonds are issued by companies, carry higher risk, and typically offer higher yields.
 

Investment bonds: key takeaways

Investment bonds can provide stability, regular income through interest payments, and a potential hedge against market volatility, making them highly valuable if you’re looking to balance investment risk and return over the long term.