Bonds are a fundamental part of capital markets, providing access to debt capital.
Investors in bonds lend money to an entity in return for regular interest payments. When you hold a bond to maturity you receive the face value of the bond back.
The main reasons people invest in bonds is to provide a stable income stream, lower risk and diversify their portfolio. However, the level of risk depends on the type of bond being issued.
Most people have heard of government bonds. These are the safest bonds because you are guaranteed a rate of return.
While government bonds are considered very safe, the rate of return is generally quite low, especially in this low-interest rate environment.
Corporate bonds are riskier than government bonds. If a company goes out of business “you won't get coupon payments and may not get your principal back”.
However, as the Moneysmart website goes on to say, corporate bonds are less risky than shares. This is because bond holders get paid out before shareholders in the event of a collapse.
A 2018 Deloitte report claimed there was more than $1 trillion of corporate bonds in Australia - 70% the size of the listed share market.
But with only 47% of the Australian bond market owned by Australian investors, the government is interested in investigating why.
According to Deloitte, private investors hold less than 1% of all corporate bonds in Australia. The figure is almost 20% in the United States.
This lack of interest appears to be fuelling the recently announced inquiry.
With an average gross annual return on bonds of 6.1% between 2006-16, much higher than the 4.3% for Australian shares, why aren’t more Australian investors getting into the corporate bond market?
Deloitte claims a lack of understanding among investors is one key barrier to the take-up of corporate bonds in Australia.
It is also argued that market innovation is needed to create easier access to individual investors, but this is beginning to change.
With safe investments such as government bonds and term deposits offering limited returns to investors, it will be interesting to see if the government’s new inquiry will yield (pardon the pun) any benefits for older Australians crying out for alternative investment options.