Every investment has its potential, presenting various opportunities for different levels of investors. In and amongst those sit corporate bonds. But with so many bond types out there, how exactly do they differ from each other and investment vehicles, and in today’s financial climate, what can they bring to the table to benefit various goals?
What are corporate bonds?
Corporate bonds are issued by private or public companies to investors who lend funds to support various businesses processes or projects. This can involve anything from leasing new office spaces to purchasing inventory. In return, bond issuers have a legal obligation to provide bondholders with repayments at either fixed or variable rates until the bond matures, at which point the original funds are returned to the lender with the agreed interest. The term time and interest rates of corporate bonds are both predetermined, and term times can range between short term (under 3 years) and long term (over 10 years).
Companies can choose to issue bonds rather than borrowing from the bank as a bank loan can incur larger interest fees, so it’s often more cost-effective to issue corporate bonds instead. Bonds can also offer better terms for the issuer than a bank loan.
Like many other bonds, corporate bonds are graded on their quality, like a credit rating. The highest grading is AAA and the lowest is BBB or below. Bonds with the lowest grading are often known as “junk bonds”.
Types of corporate bonds
A secured corporate bond is backed by the bond issuer’s collateral. This means that, if the bond agreement fails, the investment funds are secured against an asset. This could be a physical property such as a warehouse, inventory, or other asset types, which the bondholder will have legal access to if the agreed repayments are not met.
Also known as debentures, unsecured bonds mean that investments are unprotected against payment failure and rely solely on the trust that repayments with the agreed interest will be paid on time by the bond issuer.
· Fixed rate
One of the most common bond types, fixed-rate corporate bonds come with a fixed interest rate throughout the agreed term time. Rates are typically determined by the bond issuer.
· Variable rate
Unlike fixed-rate bonds, variable rates mean that the interest rate associated with that bond will fluctuate with the annual market performance.
· Floating rate
Like variable-rate bonds, floating rates change the bond’s interest rate based on market fluctuations, but these changes are more frequent – they are usually quarterly rather than annual.
These are interest-free bonds. Zero-coupon bonds tend to be discounted and there are no interest payments involved during the bond’s term time. At maturity, investors can sell their zero-coupon bond at face value.
A high-yield corporate bond is likely to have a low bond rating and is another term for ‘junk bond’. These bonds can offer high returns but tend to come with increased volatility due to their low rating.
Callable bonds come with what’s known as a ‘call date’. This is a voluntary process, and it means that issuers are entitled to buy bonds back from investors at a set date, but before the bond matures. Callable bonds can be fixed, variable, or floating rate bonds, and the issuer normally pays face value for them as well any interest that may have developed during that time.
Putable bonds are the reverse of callable bonds. With putable bonds, the bondholder is entitled to request early repayment from the issuer along with any interest that may have built up over that period.
Convertible corporate bonds enable the holder to convert the bond into the issuer’s stock. In other words, investors can exchange convertible bonds for equity in the company. However, there are rules on how and when bonds can be converted, similar to callable and putable bonds.
Corporate bonds vs stocks
While stocks provide investors with partial ownership of a company, corporate bonds are a loan system whereby investors lend funds to companies for a pre-agreed rate of return. Corporate bonds (and all other bonds) do not involve any equity.
Bonds can offer a more reliable picture of your expected returns as, at the point of purchasing a corporate bond, you are agreeing to a certain rate and term time, so you are aware of the returns you will receive and when. Stocks, however, can fluctuate unexpectedly with market performance and can often be based on future predictions for the company, which can be inaccurate.
In terms of trends among investors and how corporate bonds have historically stacked against stocks, the below data displays the performance of the two investment types on a global level over 15 years.
At the point of the financial crisis in 2008, equities plunged by over 40% from the previous year as uncertainty rose among investors. The following year, that trend took a U-turn as equities increased again by nearly the same amount. During this time, corporate bonds saw a small decrease of just 4.7%, followed by significant growth of over 16%. So, while equities have shown to be quite erratic, corporate bonds have shown to be more balanced and reliable across two decades.
Corporate vs government bonds
Often known as treasuries in the US and gilts in the UK, government bonds are issued to investors by government groups. Invested funds are used to support a variety of public and government-based projects. Like other bonds, government bonds come with an agreed interest rate and term time, with regular payments being issued before the bond matures.
One of the key differences between corporate bonds and government bonds is that there are fewer types of government bonds to choose from. In the UK, the two primary government bond types are:
· Government gilts
These are standard government-issued bonds that come with an agreed fixed rate of return. Payments are made at regular intervals for the agreed term with interest.
· Index-linked gilts
You can invest in government bonds without a fixed rate of return. Instead, the rate will fluctuate over the term time of the bond with inflation and the UK retail price index (RPI).
In the US, there are a few more government bonds such as Treasury Bills (under 1 year), Treasury Notes (1-10 years), Treasury Bonds (over 10 years), and Treasury Inflation-Protected Securities (also known as TIPS, which move with inflation).
While there’s risk involved with all investments, government-issued bonds can fall quite low on this scale when compared to other investment vehicles as funds are backed by established government bodies. However, no investment is risk-free. Some of the potential challenges around government bonds involved interest rates, inflation, and currency. Bonds which are not index-linked can be more susceptible to rising interest rates and inflation, which can cause the bond value to depreciate, and if the currency of the bond pay-out is different from the purchase currency, then the exchange rate can also de-value a bond, so there are a few areas to be vigilant with when it comes to government bonds.
Pros and cons of corporate bonds
Like any other investment vehicle, corporate bonds have their own benefits and drawbacks, and what may be an advantage to some may be a disadvantage to others. Below are a few potential pros and cons to consider, to help decide if corporate bonds are right for you.
|Corporate bondholders tend to have priority over shareholders in terms of receiving payment
|On average, the reduced volatility of bonds can sometimes translate to lower returns
|Bonds have historically shown stable performance, which could help with building a balanced portfolio
|Investors can be exposed to credit risk if the bond defaults
|Potential to offer a reliable income stream
|Investors can be exposed to interest rate risk, which can devalue bonds
|Bond ratings offer clarity on credibility potential
|May not provide capital growth
|Profit potential if bonds are sold once bond values rise
|Bonds can be called by the issuer, meaning that returns can be reduced
Diversifying with corporate bonds
Another advantage that corporate bonds can offer is the diversification opportunities. To maintain a healthy and balanced investment portfolio, it’s a good idea to diversify across a variety of assets to help spread any negative impact.
If corporate bonds are not yet part of your portfolio and it’s something you’re considering, a good place to start could be with bond ratings. Depending on your attitude to risk, it’s useful to evaluate some potential corporate bonds based on their rating to picture how they’d fit into your portfolio and how they’d benefit your existing assets.
If you’re already invested in corporate bonds, there is room for further diversification with this investment method through the bond type, term time, or industry, for example.
For an idea of how different asset classes can impact each other in a portfolio, the below chart shows the historical performance of US equities, global equities, US bonds, global bonds, and cash, and their gains and losses.
While equities have shown to generate higher returns, they have also experienced the biggest losses. So, for risk-averse investors, this chart offers a useful representation of the stability of returns associated with bonds and the advantage of adding corporate bonds to portfolios.
Another way to diversify with corporate bonds is through exposure to different sectors. For example, if your portfolio doesn’t yet contain property, investing in this asset class could be beneficial in the current financial climate.
In terms of opportunity in the UK real estate market, house prices have been reported to have risen at their quickest annual pace to November 2021 since 2006, and even after the stamp duty holiday, prices have continued to increase. Looking ahead, industry experts at JLL predict that house prices will maintain an upward trend over the next 4 years, with annual increases ranging between 3% and 4.5%. The regions which are expected to experience the largest growth are the West Midlands and Birmingham as well as the South West, Yorkshire, and Scotland.
With house prices staying strong, there seems to be some healthy investment opportunities on the horizon for the UK real estate market, and with corporate bonds, there is the added benefit of a hands-off approach to property investing without the need to manage a physical property.
How to invest in corporate bonds
If you’re interested in indirect property investing via corporate bonds, at Propiteer Capital PLC, we have a selection of investment models to offer. To aid diversification, our bonds span a variety of asset classes and nationwide locations:
· Renting of completed buy-to-let apartments
· Popular locations in transient cities
· Purpose-built quality living units
· Acquisition decisions based on rental income
· Recession-resilient asset class
· Occupancy delivered from Hilton and Marriott booking engines with 230 million members combined
· High-demand locations
· Up to 20 years’ regional exclusivity per hotel
· Ultra-efficient ‘focused service’ models for higher profits
· Both hotel brands have 7 ‘focused service’ sub-brands to help target each geographical region
· Build-to-sell projects completed and sold to release development profits
· Cover UK’s most robust locations
· A Private Rental Scheme running in Dublin, Europe’s fastest-growing economy with unit values based on rent
· Robust against inflation via quality properties within the London halo effect and high demand growth regions
· Private rental schemes valued on high yields and become more popular during recessions
The properties that we finance with investor funds are also spread across a range of locations in the UK and Ireland, which is another factor that helps with portfolio diversification.
Our asset-backed corporate bonds are all secured and fixed-rate returns range between 5.5% and 9.5% pa, with flexibility in both term time and exit notice period.
If you’d like to find out more about our bond products and how to get involved, visit our website or give our friendly team a call on 01376 319 000.
Rates are accurate at the date of publishing. For our latest rates, please visit our homepage.
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