YOUR MONEY: There’s good value in bonds, but invest for the long term

Question:

As a retail investor I am looking to put money into the bond market. What high-yielding bonds do you recommend? How do I go about investing in them  (through what platform)?

— G Alexander 

Answer:

South African bonds offer good value now with yields on longer-dated bonds trading above 11%.  We cannot recommend specific bonds without doing analysis on the reader’s investment requirements, risk profile and tax status. However, there are a few issues that the reader needs to take into consideration:

Investing in bonds can be risky over short- to medium-term periods. It is possible to experience significant capital losses with bond investments. Bonds pay a fixed coupon (interest), so when interest rates increase, some bond investors sell out and invest in cash if they can earn a higher rate there. Rising inflation tends to result in bond investors switching out and investing in other assets. This causes the price of bonds to fall, resulting in a capital loss. Bond investors who hold a bond to maturity are unlikely to experience a capital loss as the issuer will buy the bond back at its nominal value. So the investor must be able to endure significant capital volatility in the short term.

Bond coupons are subject to income tax. The investor needs to consider the tax implication of bond yields when deciding how much to invest.

Returns from bonds are treated as interest from a tax perspective. The first R23,800 (for those under 65) or R34,500 (for those 65 and older) of interest or coupons are tax free. Any interest earned above those amounts is subject to income tax. Someone under 65 would be able to invest about R220,000 before they started incurring tax. This amount increases to R320,000 for someone 65 and older. The reader could consider a guaranteed product that offers a tax arbitrage, which  would result in a higher after-tax return.

Investing directly into bonds requires large lump sums — typically R1m and more to buy just one bond. The best for most retail investors is to invest in either a unit trust bond fund, or a bond exchange traded fund (ETF). The ETF is a good option from a cost perspective, and all the big ETF providers such as Satrix, 1nvest and Sygnia offer them.

The graph below shows there’s little performance difference, and the reader can see the volatility.  ETFs can be accessed via any share portfolio or directly with the ETF product provider, or the reader can invest via one of the large unit trust providers.

— Craig Gradidge,  investment and retirement planning specialist at Gradidge Mahura Investments

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