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What role can different bond types play in a portfolio?

by Ozva Admin

Bond issuance is huge and constant, creating a stream of potential new investments for clients.

In a 58-page Market Trends report on corporate bonds, published at the end of 2020, the OECD said the global stock of non-financial corporate bonds outstanding reached an all-time high of $13.5 trillion (£11.37 trillion). ) in real terms.

The OECD report said: “This record amount is the result of an unprecedented buildup in corporate bond debt since 2008 and a further $2.1 trillion (£1.76 trillion) in non-financial corporate loans during 2019, following a return to more expansionary monetary policies at the beginning of the year”.

The report stated that its focus was on a data set of “more than 92,000 unique corporate bond issues by non-financial companies from 114 countries between 2000 and 2019.”

And then there are the billions of pounds of government bonds to consider.

Lexicon

It is worth talking about some of the language used in fixed income, which can be confusing to the common customer. For example:

  • A bond can be called a coupon, issue, corporate debt, company paper, bill, certificates, credit, sovereign or fixed interest.
  • You may be paid a yield, coupon, interest, dividend or rent. These all generally mean the same thing, but different fund groups may use different terminology, so it’s worth clarifying that the consumer knows what their expected return would be.
  • You need to know what a maturity date is and what a bond duration is, and they don’t necessarily have to be the same as each other.
  • There is the spread, which is effectively the yield of a bond relative to the yield of its benchmark/another bond with a different maturity.

Different types of bonuses

There are also all kinds of themes and variations: sovereign bonds, corporate bonds (investment grade and high yield), green bonds and others. Government bonds have their own nicknames: UK government bonds are gilts; US Treasury bonds are Treasury bills.

Within the world of corporate bonds, there are categories and subcategories, such as Co-cos, Tier 1, Panda bonds, junk bonds; a brief summary of some of these can be found in the information box below.

They can all have different yields, and the difference between the yield on a government, corporate (investment grade) and high yield bond is known as the spread.

A Pimco spokesperson explains: “Typically, the yield on a bond issued by a company would be higher than the yield on a government bond of the same maturity, as governments tend to have better investment ratings than private companies.”

“The riskier the issuing company is perceived to be, the wider the yield spread on its bonds relative to government bonds will be,” the spokesperson adds.

This is why an investor may be attracted by the potentially higher rate of return promised on a low-credit, high-yield bond despite the higher associated risk.

Because bonds have tended to perform differently than stocks, they have been used to provide diversification.

The OECD stated: “Compared to previous credit cycles, the current stock of outstanding corporate bonds has lower overall rating quality, higher repayment requirements, longer maturities and lower investor protection.”

Not surprisingly, Michael McEachern, Co-Head of Public Markets at Muzinich & Co, comments: “Bond investors must contend with inflation, the potential for recession and global macro uncertainties.

“At the end of the day, credit has an asymmetric risk profile, that is, a company defaults or pays at par at maturity.”

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