Can I buy Bonds in my SMSF

Can I buy Bonds in my SMSF?

Yes, you can buy bonds as part of your SMSF investment strategy. Bonds can play an important role in diversifying the fund’s portfolio. A bond is generally considered a defensive investment, and the fund’s bond portfolio can be further diversified across sectors. As with any other investment, it must be part of the fund’s investment strategy, allowed in the fund’s trust deed, and made solely to provide retirement benefits to the fund’s members or their beneficiaries if a member dies. It may be possible to invest in international bond markets, but this article is restricted to SMSFs and the Australian bond market. All Self Managed Super Funds setup by SMSF Australia have a flexible deed and investment strategy which will automatically allow for bonds along with all other investments options available to trustees.

What is a Bond?

The government or corporations issue bonds to investors. In essence, these are debt securities issued by a corporation or government. They are loans or promises to repay the principal (the face value) with interest over a specific period. An SMSF can earn regular interest at higher rates than a term deposit. Bonds are considered less volatile than shares, with strong cash flows and a high likelihood of capital redemption at maturity.

Common types of Bonds

The four most common bonds include:

1. Australian Federal Government bonds are considered low-risk, low-return investments because they are backed by the government and are highly unlikely to default, provided you hold the bond until maturity. The bonds are highly liquid and can be traded in small parcels, with maturities ranging from 1 to 12 years. Some government bonds are also available with longer maturities, such as 30-year bonds.
2. State and Territory Government bonds are issued by state treasury corporations and offer higher yields than federally funded bonds, reflecting a slightly higher risk. Typically, state governments issue bonds to fund infrastructure projects. Each state has its own credit rating and returns on investment.
3. Investment-grade corporate bonds are issued by companies such as BHP and Telstra, with strong financial records, highly rated by rating agencies such as Moody’s, S&P Global Ratings and Fitch Ratings and considered unlikely to default. The coupon rate (interest rate) reflects the risk undertaken by investors. Corporate bonds introduce diversity across a wide range of market sectors.
4. Non-investment-grade corporate bonds have a higher risk of default and therefore carry higher interest rates to compensate for that risk. They are also commonly referred to as high-yield or junk bonds. New companies often fall into this category because it is too early for them to have established a high credit rating.

Can an SMSF trade bonds?

An SMSF, like other investors, can trade bonds on the secondary market, where investors buy and sell existing bonds. Licensed brokers or exchanges can facilitate these trades. The ASX and over-the-counter markets are examples of secondary markets. When trading bonds, it is important to consider the bond’s yield to maturity (YTM). Bond prices are inversely related to YTM.  Higher expected yields are associated with lower market prices that investors are willing to pay for the bond, whilst lower expected yields are associated with higher market prices. YTM is the total expected return an SMSF will receive if it holds the bond to maturity, considering the price paid for the bond, the total coupon payments (total interest payments), and the payout the fund will receive when the bond matures.

When interest rates fall, older bonds become more attractive because their coupons are higher, giving investors a higher return. Therefore, investors are willing to pay a premium to obtain the income stream. Conversely, when interest rates rise, older bonds become less attractive and thus less valuable. If an investor needs to sell, they may have to offer a discount.

What is my SMSF’s risk of non-repayment?

Bonds are generally considered low risk. Government bonds are almost risk-free, and companies in financial difficulty must pay bondholders before paying shareholders. Bonds offer security and regular income (which can help to meet SMSF Pension Payments) and are generally easy to liquidate.

However, risk is always offset by return. Typically, the higher the interest rate, the greater the risk of non-repayment.

Inflation risk

Fixed-interest bonds are susceptible to inflation risk. For example, if your SMSF purchases a fixed interest bond at 4% p.a. and inflation is 3%, the fund’s real rate of return on its investment is only 1%. As inflation pressures increase, the fund could end up with a negative return. Indexed bonds, or inflation-linked bonds, are adjusted to the consumer price index (CPI) or another index and are designed to protect the investor from inflation risk.

Interest rate risk

As interest rates fluctuate, there is a risk that the bond price on the secondary market will either rise or fall in response.

How can an SMSF invest in Bonds?

There are many ways an SMSF can invest in bonds, including:

• Managed Income Portfolio Service – Companies such as FIIG Securities provide a professional portfolio management team to assist SMSF investors in deciding which corporate bonds your fund should include in its portfolio. Your SMSF directly own the bonds, but the portfolio is constructed and managed by FIIG, ensuring alignment with the fund’s investment strategy.
• Australian Securities Exchange (ASX) – Exchange-traded Australian Government Bonds can be acquired through a share broker, similar to shares, and are either ‘Exchange-traded Treasury Bonds’ (eTBs) with fixed interest payments or ‘Exchange-traded Treasury Indexed Bonds’ (eTIBs) with interest indexed to inflation. Corporate bonds such as AGL Energy Ltd (AGLHA), Qube Holdings Ltd (QUBHA) and National Australia Bank Ltd (NABHA) are traded on the ASX.
• Exchange Traded Funds (ETFs) and Managed Funds – There are a number of ETFs and managed funds that invest 100% in fixed income. The entry point for these investments is low, allowing access to a variety of market sectors.
• Corporate or government bonds can be acquired directly in the over-the-counter bond market via a licensed fixed-income broker, such as FIIG Securities or the Australian Bond Exchange, acting on the investor’s behalf, for as little as $10,000. However, the broker may require a minimum portfolio balance of $50,000. The bonds are purchased in the fund’s name, and the fund’s trustee can purchase or sell them at a time suitable for the trustee, but they must be held in a licensed safe custody arrangement. Some state and territory bonds can be purchased directly from the issuer for as little as $5,000.