Bonds don’t usually demand headlines like stocks – they’re often seen as the quiet achievers of investing.
But recent trade upheavals, driven by the Trump Administration’s dramatic tariff changes, has shaken up bond markets, putting them under similar pressure as share markets.
With all this attention, now is a great time to take a closer look at how bonds work and what they could mean for your portfolio.
What is a bond?
A bond works a bit like an interest-only loan except you’re the lender, not the borrower. There are many different types of bonds available. A government (government bond), or sometimes a large company (corporate bond), issues bonds to investors to raise funds for infrastructure or, in the case of a company, for expansion.
Large institutional investors tend to favour some of the more complex types of bonds. Retail investors are more often interested in fixed-rate bonds, known as a fixed-income investment because of the regular payments made to the investor (or the coupon interest rate). The principal (called the face value) is repaid at an agreed date when the bond matures.
These bonds can also be traded on a secondary market by those who’ve chosen to sell their bonds before maturity. In this case, depending on the state of the markets and the economy, the amount they’re worth, or their capital value, may be higher or lower than the face value, which is fixed.
The most common fixed-rate bonds, issued by governments, are generally considered more stable. Nonetheless, all bonds are assigned a credit rating by independent rating agencies such as Standard & Poor’s or Moody’s.
Australia’s Commonwealth bonds, issued by the federal government, are AAA-rated reflecting strong fiscal management, economic stability and low default risk.
State governments and quasigovernment organisations such as the World Bank also issue bonds. The risk level for this category of bonds can vary.
Large companies, looking to expand or start new projects, often use bonds as a way to raise funds. Corporate bonds generally pay higher interest but are considered slightly more risky.
How to buy bonds
Investing in bonds can help to diversify a portfolio and provide a steady stream of income.But for those with no knowledge or experience of the market, it is important to get quality professional advice.
For example, if you have always believed that bond markets often go up when share markets go down, recent share market activity would have shocked you. The usual flight to safety from share price volatility to bonds did not happen in the United States where, for a time, both markets were falling.
While it is possible to buy bonds directly when there is a public offer, it can be difficult for smaller individual investors to participate because of the large minimum transactions required.
Instead, most retail investors look to bond funds, bond exchange traded funds (ETFs) or managed funds for exposure to the bond market. The variety of funds on offer can help to diversify a portfolio by giving access to a range of different markets.
What affects bond rates?
Interest rate movements directly affect bond prices on the secondary market.
When interest rates rise, bond prices fall because newly issued bonds will be at the higher rate, making older bonds less attractive and reducing demand.
Conversely, bond prices rise when interest rates fall because new bonds will offer the lower rates, meaning there will be higher demand for older bonds, driving their prices up.
Bond prices are also influenced by economic conditions and investor sentiment.
Rising inflation can cause bond prices to rise while strong economic growth may decrease bond prices because investors often prefer to buy shares. Bonds with a lower credit risk, such as AAA-rated government bonds, tend to attract higher prices.
Next steps
If you would like to learn more about your options for investing in bonds, or need help deciding on the right investing strategy for you, contact your trusted Nexia adviser.
