In a report titled Not All Bonds Are Created Equal: Looking behind the yield of unlisted bonds, credit analyst John Likos and associate analyst Ravi Reddy said they were becoming “increasingly concerned” about the behaviour of investors in the space.
“As interest rates remain low, investors continue to seek yield – often captivated by headline returns without regard for the accompanying risks of those investments,” the report said.
Recent strength in the bond markets is creating a sense of overconfidence when it comes to navigating bond risks, Morningstar said.
Those risks have become subdued in a favourable global environment of low interest rates and high liquidity, it said.
The report lists a number of key ‘takeaways’ for investors when it comes to the unlisted bond market.
“Exploiting potential value opportunities in unlisted bonds should generally be left to sophisticated, experienced fixed-income investors with a high risk tolerance,” Morningstar said.
Furthermore, investors should ensure they understand the bonds they hold, how they are correlated with one another and how they would react in a market downturn, the report said.
Investors should also remember the function of bonds in a portfolio – ie. capital preservation, stable income and diversification – and realise that unlisted bond exposures may “compromise these critical functions”, it said.
Given that the bond market is more opaque than the equities market, investors should demand full disclosure of fees and charges when transacting in direct bonds, Morningstar said.
“Most retail investors are better served accessing the fixed-income asset class via managed funds, exchange traded funds or listed alternatives,” the report concluded.
