Credit where credit’s due
The past couple of years have been challenging for domestic bond investors. The Bloomberg NZ Bond Composite 0+ Yr Index declined approximately 6% in 2021 and 7% in 2022. However, in 2024, declining interest rates led to a strong recovery in bond returns, reaffirming the importance of bonds in a well-diversified portfolio.
According to the September 2024 Morningstar KiwiSaver Survey, nearly 40% of KiwiSaver assets are allocated to cash, New Zealand bonds, and international bonds. Given this, it’s timely to revisit a key concept in bond investing: credit risk. Specifically, we’ll explore the differences between government and corporate bonds, their risks, and returns.
The credit spread
Put simply, when we lend to a non-Government or corporate issuer we expect some extra return over and above what we would get if we were to buy a bond from the government. That difference in return is the credit spread.This is fairly intuitive - the New Zealand Government is unlikely to default on its obligation to repay the interest owed or the face value of the bond at maturity. Global ratings agency S&P Global assigns its highest issuer domestic credit rating of AAA to the New Zealand Government.
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