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Start investing: Why choose global investment grade corporate bonds over cash or short-term investment?

26 Jun 2023

Ashis Dash

Director and Head of Fixed Income Funds, HSBC Wealth and Personal Banking

 

Following successive rate hikes by major central banks during 2022 and H1 2023, deposit rates in many developed markets (DM) have become more attractive. The hawkish moves by key DM central banks have also pushed bond yields higher.

While short-term investments, such as time deposits and short-term funds do have their benefits within a portfolio, global investment grade (IG) corporate bonds may be preferred due to the following reasons:

  1. Longer-term growth potential: Yields are currently at a decade high, offering a good entry point to invest in global IG corporate bonds as policy rates are at or near their peaks in developed markets. If the global economy remains resilient, global IG corporate bonds may deliver higher income than USD term deposits. Even if policy rates fall, investors may still benefit from price appreciation, in addition to the coupon, as yields move lower with the fall in policy rates, likely offsetting wider credit spreads.
  2. No lock-in period: Global IG corporate bonds allow for daily trading and don’t have lock-in periods, nor any penalty in case you need to withdraw your money before the pre-set time period such as with time deposits.
  3. Lower reinvestment risk: Investing in fixed-term deposits involves reinvestment risk if rates drop. For example, a 1-year USD term deposit pays 4%. If interest rates fall by 1% over the next 12 months, investors will only be able to roll over their maturing term deposits at 3%. In contrast, global IG corporate bonds, which currently have a duration1 of 6 years and yield 5%, would earn investors 11%2, assuming no changes to credit spreads.
  4. Diversification: Global IG corporate bonds tend to have a negative to low correlation with equities during bear markets. Since 2000, the Bloomberg Global Aggregate Corporate Index (hedged to USD)3 has shown a correlation of -0.5 to 0.1 with the MSCI World Index during periods when equity markets sold off by over 20%. The only exception was 2022 when the correlation was 0.5. Therefore, global IG corporate bonds can be a helpful diversifier within a portfolio, especially during a recession.

Based on data from 2000 onwards, bonds have generally outperformed cash once policy rates have peaked because of the higher rate sensitivity of the asset class. Although tempting, higher yields on cash and short-term bonds come with an opportunity cost of missed returns during periods of looser monetary policy, and/or recessions, as yields often decline when central banks ease monetary policy.

Accessing global investment grade corporates through funds

Accessing global IG bonds through mutual funds allows investors to participate in a diverse portfolio, holding a range of securities from many different issuers and maturities. This reduces the effects of specific risks linked to individual issuers/bonds and can help in better preserving capital, generating returns and ensuring liquidity compared to holding a single security. Nevertheless, investors should also be mindful of the risk of losing their capital when investing in mutual funds and the costs incurred for investing in these funds. 

Investors who capture current high bond yields are likely to receive better returns over the lifetime of the bond than by holding cash

Source: Bloomberg, HSBC Global Private Banking as at 24 May 2023.

Notes:

1. Duration of the Bloomberg Global Aggregate Corporate Index (hedged to USD) is c. 6 years.

2. Duration measures the sensitivity of a bond’s price to changes in interest rates. For a bond (or a fund) with duration of 1 year, a fall in interest rates by 1% would mean that the bond’s price will increase by approximately 1%, assuming no changes to credit spreads. Similarly, for a bond with 6 years of duration, its price will increase by approximately 6% when interest rates fall by 1%, plus the 5% yield, getting to a total return of 11%. 

3. Data for Bloomberg Global Aggregate Corporate Index (hedged to USD) is available from Sep 2000. For periods prior to that Bloomberg US Corporate Bond Index has been used.

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