Corporate bonds can have a vital part in the portfolios that you manage for your clients. Many households are looking for steady income. Others are worried about market swings and want something more stable than equities, but more rewarding than cash.
In this article, Wealth Professional will discuss the basics, benefits, and drawbacks of corporate bonds. We’ve also rounded up the latest news on corporate bonds for you at the bottom of this article.
Corporate bonds are debt securities issued by companies to raise money. When your clients buy a corporate bond, they are lending to a business. In return, they receive regular interest payments and, in normal circumstances, their principal back at maturity.
Every corporate bond comes with these features:
Corporate bonds sit between cash and equities on the risk spectrum. They are usually riskier than Government of Canada or provincial bonds, so they offer higher yields as compensation.
Are your clients new to bonds? Check out these four key lessons in bond investing from experienced portfolio managers to help them learn more!
Your clients can hold corporate bonds in several ways such as:
Individual issues can involve wider bid-ask spreads than benchmark government bonds. Spreads can widen further in periods of stress, especially for smaller or lower rated issuers. Funds and ETFs improve diversification and daily liquidity but add management fees and market price swings.
Most bond trades in Canada now settle on a T+1 basis. This faster settlement can help you line up cash flows more precisely when you rebalance portfolios for your clients.
Corporate bonds can support many of the planning conversations you have with your clients. Here are some of the main advantages:
Corporate bonds usually pay higher yields than similar government bonds. The extra yield is the credit spread your clients earn for taking on issuer risk.
For income-focused households, that spread can make a real difference. Retirees, pre-retirees, and business owners who want predictable income often find corporate bonds helpful. They can receive more income than with government bonds, without moving entirely into equities.
Within fixed income, corporate bonds add issuer and sector exposure that government bonds do not provide. Your clients can gain exposure to sectors such as:
A diversified mix of corporate issuers can reduce reliance on any single company or sector. It can also spread out credit risk. Many financial advisors use corporate bonds to complement government bonds, Guaranteed Investment Certificates (GICs), and cash. Plus, they can use these bonds to add depth to fixed income allocations.
Corporate bonds can help match future spending for your clients. When you build a simple bond ladder, you can line maturities up with their personal goals such as:
With a ladder of investment grade corporate and government bonds, your clients can see when principal is due back. Coupon payments add income along the way. This can reduce anxiety about short-term market moves and help your clients focus on long-term goals.
Corporate bonds move with interest rates and credit spreads. When government yields fall and credit spreads stay steady or tighten, investment grade corporate bonds can gain in price.
For your clients who hold corporate bond funds or ETFs, this price gain shows up in the fund's net asset value. For those who hold individual bonds and do not sell, the price change is mostly theoretical, but it still reflects the market value of their holdings.
Corporate bonds are not a guarantee of profit, but they can benefit in periods when central banks cut rates or when credit conditions improve.
Corporate bonds offer many ways to fine-tune risk and income for your clients. You can choose across maturities, credit ratings, and sectors, then blend holdings to suit each household's goals.
For more cautious investors, you can focus on shorter-term investment grade issuers with strong balance sheets. For those with higher risk tolerance, you can introduce modest high yield exposure through diversified funds, while keeping core holdings in investment grade credit.
Corporate bonds also bring risks and trade-offs. Your clients need to understand these before they commit. Here are five drawbacks to watch out for:
Corporate bonds carry the risk that the issuer cannot meet its obligations that can include:
Investment grade issuers tend to have lower default rates, but the risk is not zero. High yield issuers have higher default rates. They offer higher income to compensate, but the chance of permanent loss is also higher.
For your clients, this means that investment grade corporate bonds might suit more conservative income goals. High yield bonds might suit those with stronger risk tolerance and longer horizons.
Either way, diversification across many issuers and sectors is vital. Concentrated bets on single issuers can expose your clients to sharp losses if something goes wrong.
Corporate bonds are sensitive to interest rate changes. When yields rise, prices fall. Longer-duration bonds lose more value for a given rate rise.
If your clients hold bonds to maturity, they still receive scheduled coupons and principal, so long as the issuer does not default. However, the market value can move considerably along the way. This is critical if your clients would need to sell early.
To manage interest rate risk, you can blend short, medium, and long-term maturities and use ladders rather than concentrating in one term. You must also review duration for funds and ETFs before recommending them. These steps can help smooth price swings for your clients.
Corporate bonds usually trade less often than Government of Canada bonds. As a result, they tend to have wider bid-ask spreads. Smaller issues and lower rated bonds often have the widest spreads.
In calm markets, this mostly affects transaction costs. In stressed periods, it can affect your ability to exit positions quickly at fair prices. Funds and ETFs help by pooling many investors and issuers. However, they can still see dislocations between market price and underlying value during sharp selloffs.
When your clients deal with large corporate bond positions, you might prefer more liquid issues. You might also rely more on diversified funds instead of individual names.
Many corporate bonds are callable. That means the issuer has the right to repay the bond earlier than the stated maturity date. Issuers often call bonds when rates fall or when their credit quality improves, since they can refinance cheaper elsewhere.
For your clients, an early call can create reinvestment risk. They receive principal sooner than expected and must reinvest at lower yields. When you review corporate bonds, it helps to focus on:
This can prevent surprises later and help your clients set realistic expectations around income.
Even if your clients receive every interest payment and full principal, inflation can erode purchasing power. If inflation runs above the bond's yield, the real return can be negative. This is true for government bonds and corporate bonds alike.
It is also one reason why fixed income alone is rarely enough for long-term growth goals. Corporate bonds can still earn positive real returns, especially when yields are higher and inflation is moderate. However, they should sit within a wider mix that includes equities and possibly real assets, depending on your clients' goals.
You might be wondering if investing in bonds suits your clients' financial profile and risk appetite. Want to know if you should advise them to invest in bonds or stocks instead? Watch this video to find out:
Find out what could cause bond volatility and how financial advisors can prepare in this linked article.
Corporate bonds can be worthwhile for your clients when they fit into a thoughtful plan. They are not a cure-all for low yields or market stress, but they offer useful benefits.
On the plus side, corporate bonds offer higher income than government bonds with similar maturities and add diversification within fixed income allocations. They can also provide more predictable cash flows than equities and can gain value if yields fall or credit spreads tighten.
However, these bonds can still expose your clients to credit and default risk. They can react to interest rate moves, which can cause price swings, and can be less liquid, especially in stressed markets. Corporate bonds can also create reinvestment risk when they are callable and redeemed early.
In the end, corporate bonds are most helpful when they work with other assets to support specific goals. A mix of government bonds, corporate bonds, GICs, cash, and equities gives you many ways to balance income, growth, and safety for your clients.
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