Bonds

UNDERSTAND THE ESSENTIALS FOR INVESTMENT

What is a bond?

In brief, bonds are a form of loan where you (the investor) essentially serves as the ‘bank’. The loan can be to a company, a city or the government (the issuer). In return for lending your money you receive regular interest payments, with the issuer agreeing to pay you back the face value of the loan on a specific date.

Why do investors like bonds?

Unlike stocks, bonds don’t give you any ownership rights. However, bonds are often viewed by many as a safer investment due to the steady stream of income they generate. So when stock markets become volatile investors can often turn to bonds.

 

But this doesn’t mean bonds are risk-free…

Bonds are not risk-free for the investor. There are many potential risks to consider when thinking about investing in bonds. Here are some of the main ones:

  • Interest rate risk: When interest rates fall, bond prices tend to rise; and, when interest rates rise, bond prices tend to fall. This obviously means that you (the investor) has some exposure to changes in the interest rate.
  • Credit quality: You also have to take into account the credit quality of the issuer – and doing so is not always straight forward. For example, a bond from the U.S Government (known as Treasuries) are considered much safer than a bond from a company with a low credit rating.
  • Loan duration: How long you lend the money to the issuer also has an impact on risk. Bonds with longer durations are paid more – why? Because it means your money is tied up for a longer period of time.

 

How do I get into bonds?

There are different ways to invest in the bonds market. Here are the three most common investment options:

  • Single bonds: An investor can buy single bonds. However, you need to have a good chunk of money to get a well-diversified portfolio, and you also need to spend a great amount of time assessing the quality of the issuers.
  • Mutual bond funds: A more common way for private investors to access the bond markets is to buy a mutual bond fund. A bond fund does not have a set maturity date, as it continuously invests in bonds with different maturity dates. This provides the investor with exposure to different investments and time periods.
  • Bond ETFs: Read our guide on ETFs

BONDS FOR RESPONSIBLE INVESTORS?

Sustainable bonds are loans used to finance projects that bring clear environmental and social-economic benefits. You may also have heard of green bonds, defined as loans used to finance projects and activities that benefit the environment. The good news is that studies have shown the positive effect that environmental, social and governance investing can have on bond portfolio performance.

Before you invest in a sustainable bond fund or ETF, try to be clear on whether it supports your responsible investment goals (follow our 8-step Responsible Investment Roadmap). For example, if you really care about health care, nutrition or childhood development you might want to take a closer look at the emerging ‘social development bonds’. However, if environmental factors lie close to your heart you could focus more on the ‘green bonds’.

As always, once you are clear on goals, it is recommended you speak with your financial advisor or other expert about potential risks and available options.

What is credit rating?

What is a credit rating? A credit rating is an assessment of the creditworthiness of a borrower. This credit assessment is usually done by one of the major rating agencies – such as Standard & Poors (S&P), Moody’s or Fitch. The credit rating gives you an indication of the likelihood that the borrower will pay back a loan as agreed upon, without defaulting. The higher the credit rating, the higher the likelihood that the loan will be paid back in full.

Credit rating agencies typically assign letter grades to indicate ratings. For example, Standard & Poor’s has a credit rating scale ranging from AAA (excellent) to D (not so good). A debt instrument with a rating below BBB- is considered to be speculative grade or a junk bond, which means it is more likely to default on loans.

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