Bonds
Buying a bond means lending money to a government or company in return for regular interest payments (coupons) and the repayment of the original amount (face value) at the end of the loan (maturity). Unlike private credit loans, bonds are tradeable on public markets such as the ASX, allowing investors to buy or sell before maturity. If sold early, the bond's price will reflect its market value, which may be higher or lower than its face value. Because direct bonds often require large minimum investments (around $500,000), most investors access them through bond ETFs, which allow smaller, brokerage-level minimums and built-in diversification.
Bonds can be fixed-rate – where the interest stays the same for the life of the bond, or floating-rate (FRN) – where the interest resets, usually every few months, to a reference rate such as the Bank Bill Swap Rate (BBSW) plus a margin.
When market interest rates (e.g. RBA cash rate) change, fixed bond prices (their market value) move in the opposite direction. If rates rise, existing fixed-rate bonds fall in price and vice versa. Floating-rate bond prices are steadier because their income adjusts with changing market interest rates.
Total Return = Interest Income + Capital Gain/Loss (price change - if sold before maturity)
Like cash, bonds are defensive assets positioned toward the lower end of the risk–return scale — offering more income and risk than cash, but less risk and return potential than shares or private credit.
Common Bond Types and Investment Options
| Bond Type | Rate Type | Issuer | Typical Credit Rating | Risk / Yield Profile | Example ETFs |
|---|---|---|---|---|---|
| Australian Government Bonds | Fixed | Australian Government | AAA | Very low risk / Low yield | GOVT VGB |
| US Government Bonds | Fixed | US Government (Treasuries) | AA+ | Low risk / Low yield | GGOV USTB |
| Australian Corporate Bonds | Fixed | Australian Companies | A to BBB | Medium risk / Moderate yield | PLUS CRED |
| Australian Corporate Bonds | Floating | Banks and Large Companies | A to BBB | Medium risk / Yield moves with cash rates | QPON BANK |
| US Corporate Bonds | Fixed | US Companies | A to BBB | Medium risk / Moderate yield (exposed to FX if unhedged) | USIG |
| US Corporate Bonds | Floating | US Companies | A to BBB | Medium risk / Variable yield (less common) | FLOT |
Duration — Sensitivity to Interest Rates
Duration measures how much a bond’s price changes when interest rates move. It reflects how long it takes to get your money back through interest and principal payments.
Short-duration bonds (1–3 years) repay capital sooner, so investors are less exposed to rate changes.
Long-duration bonds (7–10+ years) have payments stretched further into the future, so their value is more affected when rates move — there are more future payments to revalue.
Example: Approximate price change for a 1% rate move
| Bond Duration | Rate +1% | Rate −1% |
|---|---|---|
| 2 years | −2% | +2% |
| 5 years | −5% | +5% |
| 8 years | −8% | +8% |
Why this happens
- When rates rise, investors can earn higher income elsewhere.
- The longer the bond’s remaining payments, the more its fixed income loses value.
- When rates fall, those same long-term payments become more valuable, leading to larger price gains.
What to Consider
Purpose – Used as a defensive asset to provide steady income and reduce portfolio volatility during market downturns. Bonds can help “weather the storm” by holding their value better than growth assets when share markets fall. They typically form the core of a diversified, medium-term allocation (around 3–7 years) — sitting between short-term cash and higher-risk assets like private credit and equities.
Time Horizon – Bonds generally suit funds not needed for at least 1–7 years once cash buffers and short-term expenses are covered. 1–3 years: short-duration or floating-rate ETFs provide income with limited price movement. 3–7+ years: core or longer-duration ETFs can capture more income and price movement through rate cycles.
Fixed or Floating – Fixed-rate bonds offer steady income and may rise in value when rates fall. Floating-rate bonds (FRNs) adjust income with cash-rate changes and remain steadier in price. Combining both can balance stability and income flexibility.
Government or Corporate – Government bonds: lower risk, lower yield, often used as portfolio ballast. Corporate bonds: higher yield, higher credit risk, add income and diversification. Many broad ETFs hold a mix of both.
ETF Structure – Bond ETFs track major indices such as the Bloomberg AusBond or global aggregate benchmarks. Larger, more liquid ETFs typically offer tighter pricing and smoother tracking relative to their index.
Currency and Hedging – Global bond ETFs can be hedged to minimise currency movement or unhedged to retain foreign-exchange exposure. Hedged options tend to smooth returns in Australian dollar terms.
Costs and Fit – Compare net yields after fees and ensure the ETF’s Target Market Determination (TMD) aligns with the investor’s risk tolerance, return expectations, and timeframe.
Risks and Limitations
Interest-Rate Risk – If market interest rates increase, the value of fixed-rate bond ETFs falls, as older bonds paying lower coupons become less attractive to new investors.
Inflation Risk – If inflation rises above the ETF's yield, the real (after-inflation) return decreases, reducing the purchasing power of income payments.
Credit Risk – If a bond issuer's financial position weakens or it defaults, the ETF's income and unit price may decline. Corporate bond ETFs are more exposed to this than government bond ETFs.
Currency Risk – If the Australian dollar strengthens, the value of unhedged global bond ETFs typically falls when converted back to AUD. If the dollar weakens, returns may rise.
Liquidity Risk – If trading activity in bond markets slows or investors sell heavily, bond ETF prices can temporarily move away from the value of their underlying bonds.
Reinvestment Risk – If older, higher-yielding bonds mature during a period of lower interest rates, the ETF may reinvest in new bonds paying lower returns.
FAQ
A direct bond is a single loan to one issuer with a fixed maturity date. A bond ETF is a fund holding many bonds from different issuers, offering instant diversification but without a fixed maturity date. ETFs trade throughout the day on exchanges and can be bought/sold at market prices, which may differ from the fund's underlying bond portfolio value.
Not exactly. The BBSW (Bank Bill Swap Rate) is the rate at which Australian banks lend to each other for short periods. It closely follows the RBA cash rate, but can move slightly above or below it due to market conditions and liquidity.
Duration measures how sensitive a bond or bond ETF's price is to changes in interest rates. A higher duration means the price moves more when rates change — for example, a 5-year duration means roughly a 5% price change for every 1% move in rates.
FRNs generally have lower interest-rate risk because their coupon payments adjust with a reference rate such as BBSW, keeping prices steadier when rates rise. However, they still carry credit risk from the issuer and can fluctuate between coupon reset dates.
The coupon rate is the fixed interest rate paid on the bond's face value. The yield reflects the return based on the bond's current market price. If the price falls below face value, the yield rises; if the price rises above face value, the yield falls.
The yield curve shows the relationship between bond yields and time to maturity. Normally, longer-term bonds offer higher yields to compensate for time and inflation risk. When short-term yields rise above long-term yields (an inverted curve), it can signal expectations of slower growth or falling rates ahead.
Hedging uses financial contracts to offset currency movements in global ETFs. It reduces the impact of foreign-exchange changes on returns but adds small costs from managing and rolling those hedge positions over time.
Australian Government Bonds are considered very low credit risk because they're backed by the government's ability to tax and issue currency. However, they still face interest-rate and inflation risk — their prices can fall if market rates rise.
If an issuer fails to make interest or principal payments, bondholders may lose some or all of their investment. Government bonds rarely default, but corporate bonds carry this risk. ETF diversification across many issuers helps reduce the impact of any single default.
A TMD outlines who a financial product is intended for, including the typical investor profile, risk level, and investment timeframe. ETF issuers must provide a TMD under ASIC rules so investors can assess whether the product aligns with their circumstances.
A bond derivative is a contract whose value depends on the performance of underlying bonds or bond indices. Some global ETFs use derivatives to replicate index returns when direct bond ownership is impractical, but most ASX-listed bond ETFs hold the actual bonds.
Interest income is generally taxed at your marginal tax rate. Capital gains or losses from selling ETFs may also apply. Always check your tax position with a qualified adviser, as rules can differ depending on the investment structure and holding period.
Reference
Consumer Information:
MoneySmart - BondsRBA - Bonds and the Yield Curve
S&P Global Credit Ratings