Corporate bonds have traditionally been an asset class mainly reserved for institutional investors with only a limited selection of bonds available to everyday investors.
Now that WiseAlpha has liberalised the wonderful world of corporate bonds for everyone, we explain in this article why corporate bonds are, in our view, a superior asset class to equities. And later, we come onto why the Brexit uncertainty has created a significant bond buying opportunity.
The data doesn’t lie. Corporate bonds give better returns for less risk.
The charts below show the performance of key indices used by the industry to assess the performance of equities (FTSE 100), investment grade corporate bonds (Bloomberg Barclays Sterling Corporate Bond Index), and high yield corporate bonds (BofAML Sterling High Yield Bond Index).
Astonishingly, both investment grade and high yield bonds have outperformed UK equities over the last 20 years both in terms of returns and price volatility.
Even over the short-term, since the beginning of the year bonds have again outperformed equities. Since the data sets began over the last 20 years, the BofAML Sterling High Yield Bond Index has returned 8.9% per annum (Year to date -ve 0.7%), while the FTSE 100 Total return index returned only 3.6% per annum (Year to date -ve 5.4%).
While bonds can also go up and down in price like equities, the volatility is not as large, and returns are protected by high income coupons and the fact that bonds have to be repaid at their face value.
Bonds should be repaid at their face value. It’s worth remembering that since many corporate bond issuers are FTSE 250 size companies, many have issued both bonds and listed equity so both provide exposure to a similar set of companies. From this perspective, bonds offer less risk and more reward. However, as with all investing capital and return is at risk
Bonds provide a greater certainty of a return than equities
Why is this?
-Dividends are uncertain and can be cut at times of financial performance weakness, whereas bond interest has to be paid contractually and in fact is prioritised over dividend income. This result is that bond income is more predictable and certain.
-Bonds have to repaid by maturity, giving you greater certainty over the return of your capital whereas equity valuations are open-ended.
-Bonds rank ahead of shares and are therefore less risky because bonds have priority over equity investors when the proceeds of asset sales are applied and because there is a contractual date when the bond matures and needs to be paid back out of cash.
In volatile markets bonds are more attractive than equities
When markets become more volatile, as they are this month, corporate bonds become more appealing as a way of locking in returns and preserving capital. And they also help to smooth out returns over time. Generally when shares underperform corporate bonds outperform — and the opposite is also true.
Corporate bonds, in particular high yield bonds, can generate income that is approximately 5–6% higher than bank deposits over the economic cycle for a bit more risk and should be viewed as a defensive investment versus equities. Although some bond opportunities can also generate double digit returns. It is not uncommon to see corporate bonds forming the largest part of a portfolio for some of the best specialist multi-strategy funds.
In conclusion, not only do we view corporate bonds superior as an asset class than equities, but right now with the Brexit vote uncertainty leading to a drop off in bond prices, the opportunity for earning high single digit and even double digit returns on bonds over the medium term is a real possibility.
Please remember that bonds are investments not savings or deposit protected products and your capital and interest is at risk.
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As with all investments your capital is at risk. WiseAlpha members purchase Notes which are fractions of individual corporate bonds.