As more Australians increase their allocations to government and corporate bonds, it is important to understand the two different ways you can make an investment.
Just like shares, you can either buy and sell them directly or you can have someone else manage them for you. In the fixed income asset class we call this direct and indirect investing.
Here are some of the advantages and disadvantages of each option.
1. Invest direct and keep control
Direct investment can require high minimum investment amounts. If you want to access the main over-the-counter (OTC) market, you will need to find a broker/ dealer to invest. Some require minimum total investment amounts of $250,000, starting from $10,000 per bond.
You can access a small number of bonds on the ASX including roughly 25 Australian Commonwealth Government bonds. There are also exchange traded bonds with individual bonds packaged into a trust structure. These are known as XTBs.
If you are interested in State or Territory bonds, these can be bought from the issuers from $5,000.
Advantages
- Choose the bonds to invest in and determine your risk/ reward profile to complement existing investments
- Funds are returned to you at maturity
- Interest is known as is the payment date
- Able to invest in foreign currency bonds
- Able to invest in securitised investments such as Residential Mortgage Backed Securities
- Much greater selection of individual bonds for sale than in the listed market
Disadvantages
- Usually more concentrated portfolios compared to funds and losses have a greater impact
- Possible illiquidity in stressed markets, particularly for high yield bonds, but can extend to investment grade bonds
- You need to take the time to understand each issuer and bond
- If buying in OTC, higher minimum investment needed
- Most bonds not listed on an exchange
2. Indirect investment – Have someone else to manage your investments
There are a range of bond ETFs and managed funds that are 100% fixed income. These can include multiple sub sectors such as cash, government, corporate, high yield and securitised investments. There are also many funds that have an allocation to fixed income that include other asset classes such as shares, property and others.
Advantages
- Great for those with limited time to learn about the asset class or read about new issues
- Lower minimum amount to invest compared to an OTC portfolio
- Good range of products to suit investor risk profiles
- Access expertise, but can pay highly for it
- Some funds hold hundreds or thousands of bonds. You can achieve great diversity in one investment
Disadvantages
- Manager determines income and when to buy and sell
- Have to decide to sell, lose the benefit of a maturity date that you get with direct investment
- No guarantee of liquidity even for funds traded on ASX
- Managed funds can be opaque, not listing underlying investments
- Many ETFs and managed funds consistently underperform their benchmarks
- Historically, some funds have ‘frozen’ in stressed markets
- Can employ complex strategies using derivatives such as put and call options and swaps
- Need to apply for units in an unlisted fund, compared to ETFs or ASX mFunds (an avenue for some unlisted funds to be traded on the ASX)
- Some managed funds have high fees
