In the 1970s, the modern bond market began to evolve. Supply increased and investors learned there was money to be made by buying and selling bonds in the secondary market and realizing price gains.
Until then, however, the bond market was primarily a place for governments and large companies to borrow money. The main investors in bonds were insurance companies, pension funds, and individual investors seeking a high-quality investment for money that would be needed for some specific future purpose.
Broadly speaking, government bonds and corporate bonds remain the largest sectors of the bond market, but other types of bonds, including mortgage-backed securities, play crucial roles in funding certain sectors, such as housing, and meeting specific investment needs.
The government bond sector is a broad category that includes “sovereign” debt, which is issued and generally backed by a central government. Government of Canada Bonds (GoCs), U.K. Gilts, U.S. Treasuries, German Bunds, Japanese Government Bonds (JGBs) and Brazilian Government Bonds are all examples of sovereign government bonds. The U.S., Japan and Europe have historically been the biggest issuers in the government bond market.
Local governments – whether provinces, states or cities – borrow to finance a variety of projects, from bridges to schools, as well as general operations. The market for local government bonds is well established in the U.S., where these bonds are known as municipal bonds. Other developed markets also issue provincial/local government bonds.
After the government sector, corporate bonds have historically been the largest segment of the bond market. Corporations borrow money in the bond market to expand operations or fund new business ventures. The corporate sector is evolving rapidly, particularly in Europe and many developing countries.
Corporate bonds fall into two broad categories: investment grade and speculative-grade (also known as high yield or “junk”) bonds. Speculative-grade bonds are issued by companies perceived to have lower credit quality and higher default risk than more highly rated, investment grade companies. Within these two broad categories, corporate bonds have a wide range of ratings, reflecting the fact that the financial health of issuers can vary significantly.
Speculative-grade bonds tend to be issued by newer companies, companies in particularly competitive or volatile sectors, or companies with troubling fundamentals. While a speculative-grade credit rating indicates a higher default probability, higher coupons on these bonds aim to compensate investors for the higher risk. Ratings can be downgraded if the credit quality of the issuer deteriorates or upgraded if fundamentals improve.
Structured products are pre-packaged investments that normally include assets linked to interest plus one or more derivatives. They are generally tied to an index or basket of securities, and are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security such as a conventional investment grade bond and replacing the usual payment features—periodic coupons and final principal—with non-traditional payoffs derived from the performance of one or more underlying assets rather than the issuer's own cash flow.
Incorporating structured products into clients portfolios can complement other allocations in your clients portfolios.
We prefer doing "one-off" custom income and growth strategies that differentiate you from other Advisors and offer exactly what you want in your portfolios.
Another major area of the global bond market comes from a process known as “securitization,” in which the cash flows from various types of loans (mortgage payments, car payments or credit card payments, for example) are bundled together and resold to investors as bonds. Mortgage-backed securities and asset-backed securities are the largest sectors involving securitization.
Sovereign and corporate bonds issued by developing countries are also known as emerging market (EM) bonds. Since the 1990s, the emerging market asset class has developed and matured to include a wide variety of government and corporate bonds, issued in major external currencies, including the U.S. dollar and the euro, and local currencies (often referred to as emerging local market bonds). Because they come from a variety of countries, which may have different growth prospects, emerging market bonds can help diversify an investment portfolio and can provide potentially attractive risk-adjusted returns.