The global bond market is $102.8trillion in size1 and offers a wide variety of investment opportunities, from different types of issuers and credit qualities, to a range of maturities.
In Australia, the bond market is split into two main types of bonds:
- Government bonds. In general, bonds issued by the Commonwealth government/government sponsored entities are regarded as low risk as the probability of default is very small. This is because the government can always use taxes to raise revenue to repay debt. As a result, these bonds are viewed as more secure and liquid, and hence offer lower yields compared to corporate bonds.
- Corporate bonds. On the other hand, issuers such as banks and corporations cannot raise taxes and therefore their probability of default is higher. But the higher an issuer’s credit risk, the higher the yield the issuer must offer to attract investors.
To build a well-diversified and high-quality portfolio, you need to think beyond a broad fixed income benchmark.
Having exposure to a variety of issuer types and maturities, to include bonds issued by corporations, state governments and foreign institutions, will increase the diversification of your portfolio. However, it will also increase credit risk.
The risk of default can also be mitigated by focusing on investment grade-rated bonds, which tend to be from companies with stronger balance sheets that are able to better withstand economic downturns.