Role of corporate bonds in a portfolio
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quanta
Posts: 7 Forumite
A recent thread has asked about the role of gilts in a modern portfolio and the response has been that they manage risk. Gilts have been negatively correlated with equity historically and so including them dampens the overall volatility of a portfolio. Makes sense to me.
What makes less sense is what role (if any) corporate bonds should play? From what I can gather, they tend to correlate pretty closely with equities and so don't offer the same volatility dampening effect of gilts, however they also have lower returns than equities. Why would an investor buy them rather than allocating their money to equity (if they want to drive growth) or gilts (if they want to dampen volatility)?
I'm sure I am missing something, would any more experienced investors be willing to enlighten me?
What makes less sense is what role (if any) corporate bonds should play? From what I can gather, they tend to correlate pretty closely with equities and so don't offer the same volatility dampening effect of gilts, however they also have lower returns than equities. Why would an investor buy them rather than allocating their money to equity (if they want to drive growth) or gilts (if they want to dampen volatility)?
I'm sure I am missing something, would any more experienced investors be willing to enlighten me?
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It depends on what corporate debt you buy. If you stick with investment grade there is little chance of default and it isn't well correlated with equity price fluctuations. I don't give this much thought as I buy both equity and bond broad index trackers......so I have government and corporate debt, mostly good quality, but a little not so good just because it forms part of the market.“So we beat on, boats against the current, borne back ceaselessly into the past.”0
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I remember reading an American writer who simply won't buy corporate bonds. He mixes equities with Treasuries. If he wants a bit more risk he rebalances towards equities; a bit less, towards Treasuries.
Another advantage of the likes of Gilts is that you can hold the actual bond and benefit from its bond characteristics. Corp bonds you'd hold in a fund of some sort, to spread the default risk, but then you've given up the bond character i.e. the certainty of interest payments and maturity date.Free the dunston one next time too.0 -
Corporate bonds lie somewhere between equities and gilts. You won't get the same downside protection as gilts but they should fare much better than equities in a downturn. To reward you for the higher risk than gilts, the yields are better which makes them useful for income investors. I wouldn't want all my retirement investments in equities and my priority is no longer simple growth. I diversify into other income producing asset classes such as corporate bonds, high yield bonds (sub investment grade which can produce much more equity like movements), property and infrastructure. Gilts aren't much use for income and I'd rather be in cash0
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I see advantages with using corporate bonds as an alternative to dividend-paying shares for an income investor. The cash returns are similar and you will find corporate bonds issued by companies that dont pay dividends.0
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I wouldn't want all my retirement investments in equities and my priority is no longer simple growth. I diversify into other income producing asset classes such as corporate bonds, high yield bonds (sub investment grade which can produce much more equity like movements), property and infrastructureI see advantages with using corporate bonds as an alternative to dividend-paying shares for an income investor..
Okay, I see the relevance to an income investor. Do they have a place for someone earlier in life seeking to accumulate?0 -
Okay, I see the relevance to an income investor. Do they have a place for someone earlier in life seeking to accumulate?
Depends on your portfolio strategy but as kidmugsy posted you could just ignore this middle ground completely and just have a mix of government bonds and equities fighting against each other.
However when both equities and bonds are looking expensive then I also side with ColdIron in not holding too many bonds and having cash (in place of some bonds) on the sidelines.
Alex.0 -
Do they have a place for someone earlier in life seeking to accumulate?
yes they do.
When you build your portfolio, you should be looking for it to fall within a target volatility range. Unless you are speculative in terms of risk (in respect of your risk-based investments) you should have corporate bonds in the portfolio. The amount you have will depend on the risk profile you are using. It is possible to reduce your risk by holding other low risk assets.I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.0 -
Okay, I see the relevance to an income investor. Do they have a place for someone earlier in life seeking to accumulate?
Yes.
You need to be broadly invested and to have a portfolio that meets your risk and return criteria and you do that by combining equities, bonds, cash, property etc. As corporate bonds are a significant part of the fixed income market I can't see a reason to ignore them. Remember your portfolio should not be designed to maximize potential return, it should be designed to maximize the probability that you meet your financial goals.“So we beat on, boats against the current, borne back ceaselessly into the past.”0 -
bostonerimus wrote: »Remember your portfolio should not be designed to maximize potential return, it should be designed to maximize the probability that you meet your financial goals.
My financial goal is to grow my portfolio as much as possible for a good retirement and as quickly as possible so I can retire earlier than 65 if possible. Its my own fault I am in this situation as I didn't put enough away earlier in my working life. I doubt I am alone in that kind of vague plan. I will consider bonds in the last 10 years but until then.....0 -
My financial goal is to grow my portfolio as much as possible for a good retirement and as quickly as possible so I can retire earlier than 65 if possible. Its my own fault I am in this situation as I didn't put enough away earlier in my working life. I doubt I am alone in that kind of vague plan. I will consider bonds in the last 10 years but until then.....
If your goal requires, or allows you to take lots of risk then your portfolio might well have a high equity content. Each individual is different.....I have a high equity allocation in retirement because I have enough guaranteed income to cover my expenses and I'm not worried about capital preservation and so I can afford to emphasize growth. Other people will need to be more cautious because a large drop in their portfolio value would greatly reduce their income and endanger the survival of the portfolio so a corporate bond allocation might be sensible. Take a look at the standard deviation of the returns associated with your asset allocation and see if you can live with that probability of failure.
Without a plan and a goal you can't really balance risk and return and so people could either be taking unnecessary risks or being too conservative and have a poor chance of getting enough growth for their plan to succeed.“So we beat on, boats against the current, borne back ceaselessly into the past.”0
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