Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 356

Corporate bonds: why now and in what structure?

Investment in fixed income is often seen as a residual allocation, made only after an equity and property portfolio has been painstakingly constructed with sector and style diversification closely scrutinised. However, the performance of various fixed income instruments in March and April 2020 clearly shows that the same level of discernment is pivotal when making fixed income allocations.

While the medium-term outlook remains highly uncertain, now is a good time to undertake the detailed work needed to understand which securities and funds have performed to expectations, and those which have seen existing risks magnified or in some cases new risks brought to light.

For investors with a medium-to-long-term outlook, and a preference for income and liquidity, the good news is that the current market is creating opportunities to reimagine defensive asset allocations, which may include quality corporate credit.

Why corporate credit?

An index-unaware, actively managed and globally-oriented corporate bond portfolio offers several advantages:

  • First, detailed credit analysis ensures that all holdings adhere to strict selection criteria aimed at avoiding defaults. Even a well-diversified portfolio can be significantly impacted by an issuer that does not meet its obligations.
  • Secondly, interest rate risks and credit spread risks can be managed to reduce volatility of returns over time. While coupon income is the dominant source of return from corporate bonds, funds with the flexibility to adjust exposure to interest rates and credit spreads can more effectively manage risk in real-time and ideally also use skill to generate additional investment return.
  • Finally, because issuers offer bonds in multiple currencies, an active manager can seek out the best relative value regardless of the currency. Implemented consistently over time, this flexible approach can lead to incremental return improvements.

Whether they be traditional managed funds or listed high yield bonds, Australian investors have never had a wider range of investment options when it comes to fixed income. Most recently, Listed Investment Trusts (LITs) have provided access to the global 'high yield' market for corporate bonds with credit ratings below investment grade. Offering attractive yields, they were enthusiastically adopted by retail investors.

However, the COVID-19 crisis has revealed the Achilles Heel of LITs - the ability of the unit price to trade below the underlying value of the assets (of course, they may also trade above the underlying value but this has not been evident in the recent crisis). Compared with other fixed income options, LITs have displayed equity-like volatility, although distributions continue to be paid. The longer-term risk is that these valuation discounts persist well beyond the duration of this crisis, a precedent evident in Listed Investment Companies (LICs) focussed on equities.

Figure 1: Average product performance, March-April 2020

Source: Bloomberg, company websites. Following are ASX/Chi-X codes - LIT constituents: MXT, NBI, KKC, PGG, GCI. ETF constituents: IAF, VGF. ETMF constituents: ECOR, EMAX, XKAP, PAYS. Hybrids: HBRD.

Quality fixed income remains attractive

Current market conditions have created a real ‘stress test’ of investment options across all asset classes. Take residential property for example. Long seen as a stable option that offered a mix of income and capital growth, scores of investors are now facing the possibility of many months with little or reduced rent, reduced ability to evict troublesome tenants, and a difficult market for sales.

For income investors, the issue is a simple lack of diversification. While corporate bonds can become difficult to sell at times, a corporate bond portfolio provides significant diversification, protecting a continuing income stream even if one issuer runs into difficulties.

Investors with large allocations to liquid cash or government-guaranteed term deposits have contended with reinvestment risk for years now, and sadly continues to loom large. Even though consumer price inflation is expected to remain subdued for some time, falling returns and cash flow from deposit products is impacting a saver’s ability to meet their commitments.

Add to this the likely reduction in equity dividends in response to profit and economic contraction, and self-funded retirees are potentially facing several years of significant income deficiency. Corporate bonds, by comparison, have clearly-defined payment schedules, and the vast majority are mandatory payments that cannot be cancelled or varied without severe consequences for the issuer. After the volatility of recent months, yields on offer relative to deposit products are the highest for some time.

With the economic outlook still highly uncertain, the spreads of lower-rated bonds have (understandably) widened much more than investment grade debt. While it might be tempting to gravitate towards the higher yields on offer in some of these instruments, it is possible that we are only at the end of the beginning of this crisis, rather than on the cusp of a sustained recovery.

If this assessment is right, there is a strong case to tend toward investment grade securities. One key fact supporting this view is that observed defaults in higher-rated bonds are orders of magnitude lower than in the high yield market, a trend proven through countless market cycles. Avoiding defaults is the single most effective way to ensure success in fixed income investing.

Figure 2: Long-term defaults, IG and HY

Source: Moody’s

Being nimble in fast-moving markets

Among the wide variety of fixed income offerings in the market, there has been considerable variability in outcomes for investors over March and April. Given the unprecedented and fluid nature of this crisis, it is difficult to establish any investment views with conviction.

While these uncertainties do extend to corporate credit as they do to all risk assets, this crisis is showing that not all fixed income instruments are created equally. With such an array of securities available in the market, additional work is not just necessary, but crucial to ensure that risks have been adequately weighed against the expected returns. Investors can increase their chances of success by exposure to well-diversified investment grade portfolios with a laser focus on liquidity and remaining nimble in the face of fast-moving markets.

 

Brad Dunn is a Senior Credit Analyst at Daintree Capital. This article contains general information only as it does not take into account the objectives, financial situation or needs of any particular person.

 


 

Leave a Comment:

RELATED ARTICLES

How to generate income without equity risk

Listed bond funds leap into market gap

Investing like Jerome Powell or the Future Fund

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.