Benefits and Risks of Corporate Bonds

Benefits of Corporate Bonds

Corporate bonds allow investors to earn high rates of income from the companies they know and love. They are less volatile than shares, and pay a fixed, predictable rate of interest. Meanwhile, they offer higher returns than government bonds, more liquidity than property and greater transparency than peer to peer investing.

Companies You Know and Love

Corporate bonds are issued by some of the worlds biggest companies. You can choose companies whose products you understand and even use as well as companies that frequently feature in the news, making it easy for you to keep on top of your investments.

Solid Returns

Corporate bonds tend to provide higher returns than government bonds. Furthermore, over the last 20 years, Sterling High Yield Corporate Bonds have out-performed UK equities (FTSE All Share) while being less volatile.

Our page on Market Statistics provides a more in-depth analysis.

Earn Predictable Income

Interest payments are fixed. The borrower is obligated to pay a certain amount of interest on predetermined dates. Dividends from shares however, are optional and can be cancelled by management at any time.

Most corporate bonds pay on a fixed semiannual schedule (every six months). The interest payment schedule is set out when they’re first issued. This gives investors clarity over how much they will be paid and when. Most bonds also have a specified maturity date, so you can time your investment to coincide with your wealth planning.

Low Maintenance

Corporate bonds are a work horse. They continually earn interest until they’re repaid. You can buy them and hold them all the way to maturity without them demanding huge amounts of time or management. They can fluctuate in price but are less volatile than stocks and shares or crypto currencies which can dramatically fluctuate by the hour and may take more time to effectively manage. Comparatively, bonds are less stressful.

Corporate bonds rank above equity, making them a relatively ‘defensive’ asset class. This means if a company goes bankrupt and ceases to operate the bond holders are amongst the first to be repaid once the assets of the company have been liquidated. They also tend to be less volatile than equities (they move up and down in price less).

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Easy Diversification

Building a diverse portfolio across different asset classes and industries is a good way to diversify your risk. Although diversification does not guarantee against loss, it does minimise the risk.

You can diversify across a range of different types of corporate bonds - fixed, floating, senior secured and unsecured. Floating bonds can be particularly useful as their coupons increase in line with increases of market interest rates, helping to protect your portfolio from interest rate risk as well as delivering a solid return.

Corporate bonds offer the opportunity to invest in a variety of economic sectors. Within the broad spectrum of corporates, there is a wide divergence of risk and yield. They can add diversification to an equity portfolio as well as diversify a fixed income portfolio of government bonds or other fixed income securities.

Secondary Market

Corporate bonds can be put up for sale at any time prior to maturity in our secondary trading market. They are sold as soon as there is a buyer for them but liquidity is not guaranteed.

Corporate Bond Risks

Corporate bonds are an excellent asset class that have multiple qualities. However, as with all investing their is a degree of risk.

Interest Rate Risk

Interest rates and bond prices typically move in the opposite direction; so when one goes up, the other goes down. Interest rate risk is the risk that prevailing market interest rates will rise and the prices of corporate bonds will fall.

Bond prices falling when interest rates rise may seem counterintuitive. However, consider an illustrative example:

You invest £100 in a Netflix bond which has 3 years left to maturity.

If interest rates increase by 1%, investors are able to invest their money in similar credit quality assets earning 1% per year over three years.

For that reason, if you decide to sell your Netflix bond after the interest rate increase, you will realise a lower price – about -3%, to offset it’s lower relative interest rate. If you choose to hold the bond until maturity you are effectively earning 1% less than bonds of similar credit risk available elsewhere on the market.

There are floating corporate bonds with a coupon that is adjusted to interest rates move and thus negate this risk but they generally offer lower returns for the privilege.

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Default Risk

Corporates issue bonds because they want money to achieve a goal. There is always a risk that the plan they have for the money doesn’t pan out and they end up defaulting on their payments. If this happens there are a number of things that could happen to your investment. This isn’t a comprehensive list but gives you an idea as to some possible outcomes.

• The company's assets are liquidated and the recovered amount is sufficient to recoup your capital investment.

• The recovered amount is sufficient to partially recoup your investment.

• The company swaps the corporate bond for equity.

• You receive new corporate bonds, perhaps with extended maturities in place of your old bonds.

• You recover none of your investment.

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Liquidity Risk

Corporate bonds operate in a secondary market. This means you can buy and sell them repeatedly. However, selling a bond relies on there being a buyer. If there is no buyer then you will not be able to sell. This is a risk as there may be a lag between you putting your investments up for sale and the sale completing.