Why Bonds Can Play an Important Role in a Portfolio

Bonds, whether issued by governments or companies, are generally considered a defensive asset. In periods of economic uncertainty, many investors turn to bonds because of their structured income and defined maturity value. Despite this, bonds are often overlooked. They typically offer lower returns than shares, especially when interest rates are low, and many investors are less familiar with how they work.

While shares, property and managed funds can all contribute to long term growth, bonds can add balance and stability to a portfolio. Their appeal often lies in the combination of regular income payments and the return of capital at maturity.

Income Stability

Most bonds are issued with either a fixed interest rate or a floating rate linked to a benchmark such as the Bank Bill Swap Rate. This structure provides a predictable income stream, which may suit investors seeking regular cash flow to help meet expenses.

Lower Volatility Profile

Compared to shares, bonds typically experience lower price volatility. Although market values can fluctuate with changes in interest rate expectations, the capital value at maturity is known in advance, provided the issuer meets its obligations. For investors intending to hold a bond to maturity, short term price movements may be less relevant than the income stream and repayment of principal.

Fixed vs Floating Rates

Fixed rate bonds can be more sensitive to interest rate movements. When rates rise, newly issued bonds may offer higher yields, which can reduce the market value of existing fixed rate bonds.

Floating rate bonds adjust their interest payments in line with prevailing market rates. In a rising rate environment, this feature can help maintain income levels relative to current conditions.

Portfolio positioning may vary depending on the interest rate cycle. For example, floating rate bonds may be considered when rates are rising, while fixed rate bonds can become more attractive when rates appear elevated and potentially stabilising.

Bond Basics

When governments or companies need to raise funds, they issue bonds to investors. By purchasing a bond, an investor is effectively lending money for a specified period in exchange for regular interest payments, known as coupons.

Bond terms, including the interest rate and maturity date, are set at issuance. Bonds can generally be bought and sold on the market before maturity at prevailing prices. At maturity, the issuer repays the face value of the bond. Failure to meet interest or principal repayments results in default.

The yield to maturity represents the average annual return an investor can expect if the bond is held until maturity, assuming all payments are made as scheduled.

Government vs Corporate Bonds

Government bonds are typically viewed as lower risk because they are backed by the issuing government. Corporate bonds are issued by companies and usually offer higher interest rates to compensate for the additional credit risk.

Credit ratings from agencies such as S&P and Moody’s provide an indication of the issuer’s financial strength. Bonds rated BBB- or higher are generally classified as investment grade. Bonds rated below this level are considered higher risk and may offer higher yields, but carry greater potential for default.

Investors can also gain exposure to bonds through exchange traded funds, which provide diversification across multiple issuers rather than relying on a single bond.

Bonds are not designed to replace growth assets, but they can contribute to diversification, income stability and risk management within a broader investment strategy. A considered approach, aligned to individual objectives and risk tolerance, is essential when determining their role in a portfolio.