Martin Smith l AUSIEX Fixed Income

Every adviser who has ruled out direct bonds for a client had reasons. These reasons were valid when the decision was made and some remain valid today, but others have quietly become outdated. 

With bank hybrids set to be progressively redeemed between now and 2032i, many advisers are revisiting their fixed income strategy. The real question is not whether the objections to direct bonds were invalid, but whether they still apply. 

From my experience, here are the six concerns advisers raise most often, and an assessment of which ones are still valid today. 

1. "I can't analyse credit and I don't have a research team" 

This is probably the most common objection. 

For investment grade bonds, however, the analytical task is often simpler than advisers assume. Unlike equities, you're not forecasting earnings growth or competitive advantage. You're assessing whether an issuer can make the payments required under the bond’s terms, and where bondholders rank in the capital structure if things go wrong (credit and subordination risk respectively). 

Advisers already form views on institutions such as the major banks when recommending equity investments. Assessing their debt is often a different question about the same companies rather than a completely new discipline. 

Commonly, a bigger challenge is research access. Equity investors have extensive broker coverage, forecasts and media analysis. Bond research has traditionally been less accessible. 

Fortunately, that gap has narrowed. Independent providers such as BondAdviser cover the Australian bond market specifically for advisers, while dealers including AUSIEX publish research on securities they trade. The combination of independent and dealer research provides both market insight and external scrutiny. 

Where it still holds: Sub-investment-grade and unrated issuers admittedly do remain specialist territory. The higher yields available in these segments may compensate investors for additional risk but evaluating that risk also requires specialist credit work that many advice practices are not equipped to perform. For many advisers, focusing on investment-grade credit may be practical, subject to their clients’ needs. 

2. "I can't see a price, so how do I know it's fair?" 

This concern is common and legitimate. 

Bond markets are predominantly over-the-counter (OTC). Unlike listed shares, there is no exchange displaying a last traded price. Historically, advisers often had to rely on pricing provided by the same party selling the bond. 

Fortunately, this has changed significantly. 

At AUSIEX, more than 700 bonds are displayed with independently sourced mid-market valuations. This means the valuation reported to clients is not simply a dealer's mark. Advisers can also see the spread between the reference price and the execution price, making trading costs more transparent. 

The market is still not as transparent as equities, but it is no longer opaque. 

The same old investment disciplines should still apply - Advisers should request yield-to-maturity, compare pricing across similar issuers and ratings, ask for bid and offer levels, and benchmark against recent primary issuance - but they now supplement independently sourced pricing rather than replace it. 

Where it still holds: A mid-market valuation is a reference point, not a tradeable price. Investors still buy at the offer and sell at the bid price. Spreads can widen considerably in less liquid bonds and during periods of market stress. Evaluated prices can also become less reliable when markets are dislocated. 

3. "I can't get the client out if they need the money" 

This is the objection that remains most relevant. 

The first point to understand is that most conventional bonds have a stated maturity date. For many investors, the planned exit is simply repayment at maturity, potentially avoiding a sale before maturity. 

However, clients' circumstances change. Estates require liquidity, financial needs arise unexpectedly and credit quality can deteriorate. 

In those situations, advisers are selling into an over-the-counter market. For large bank issues in normal conditions, liquidity is often reasonable but it is important to note that for smaller or less actively traded bonds, it may not be. 

The solution is portfolio construction. If a client is likely to need capital in eighteen months, consider bonds maturing around that time rather than relying on the sale of longer-dated securities. A properly structured maturity ladder provides flexibility before it is needed. 

With respect to liquidity, the comparison with fixed income ETFs is also worth making honestly. ETFs generally provide greater day-to-day liquidity because they trade on exchange. However, during stressed markets that liquidity often comes at a discount to underlying value. Investors can generally seek to sell during market hours, subject to liquidity and the price available. 

Direct bonds and ETFs therefore solve the liquidity problem differently. ETFs generally offer exchange trading during market hours. Conventional direct bonds provide a contractual maturity date, subject to their terms and issuer performance. 

Where it still holds: Internal reallocation only works at sufficient scale. Smaller practices may not have that flexibility. For clients with highly unpredictable liquidity requirements, cash, term deposits and very short-dated investments may be more appropriate than longer-dated bonds. 

4. "It doesn't scale across my client base" 

This is often true in practice, but not because of any inherent flaw in direct bonds. 

Direct bonds can be difficult to scale when each portfolio is constructed individually. Many practices have tried this approach and concluded it was too labour-intensive. 

They become much more efficient when implemented systematically. 

A defined issuer universe, a structured maturity ladder and a maturity-driven review process allow advisers to manage multiple client portfolios consistently. Unlike equities, the key events in a bond portfolio are largely scheduled and predictable. 

Most advisers have already used similar processes with bank hybrids. Hybrid allocations were rarely sourced client by client. Advisers obtained a single allocation and distributed it across multiple suitable portfolios. 

Direct bonds can work the same way. An $AUD1 million parcel can be allocated across numerous clients, subject to suitable allocations, client requirements and dealing controls. 

Where it still holds: There is still a genuine setup cost. Accounts, reporting processes, operational workflows and compliance frameworks must be established. Advisers who are not committed to implementing bonds across a meaningful client segment may find the effort difficult to justify. 

5. "A fund gives me diversification I can't replicate" 

This objection sounds compelling but is often overstated. 

In equities, diversification helps capture upside (and avoid downside risk) across multiple companies and sectors. In credit, diversification primarily serves a different purpose: reducing the impact of a single default. With Fixed income, there is typically less upside potential relative to equities, so the role of diversification is somewhat different. 

This means that practical diversification for Fixed Income can often be achieved with fewer holdings than many advisers assume, compared to equities 

Fractional bond access has also transformed the economics. Clients with several hundred thousand dollars allocated to defensive assets can often build exposure across eight to ten issuers and multiple maturity dates. Whether that is sufficient depends on issuer concentration, correlated exposures and the client’s circumstances. 

Where it still holds: High-yield credit is different. Defaults are a recognised feature of the asset class rather than a remote possibility. In that environment, broad diversification becomes much more important, and pooled vehicles often provide a better solution than direct holdings. 

6. "It's not on my approved product list" 

This is often the least interesting objection, but sometimes the real one. The issue typically combines two separate questions. 

The first is authorisation.  

Bonds are securities and are generally covered under the same authorisations that allow advisers to provide advice on listed equities. In many cases, advising on debt securities is not a fundamentally different licensing challenge. 

The second issue is the approved product list. 

In my experience, many advisers approach this incorrectly by seeking approval for individual bonds. Most licensees do not approve shares one by one. Instead, they establish investment parameters, such as limiting equity investments to an index universe. 

The same principle can be applied to bonds. An investment-grade credit framework is often more practical than approving each security individually. It also reinforces the key risk-control principle discussed earlier: staying within the segment where analysis remains proportionate to available resources. 

Where it still holds: Timing depends on the licensee structure. Self-licensed firms can move relatively quickly. Advisers operating under larger licensees may face lengthy committee and research processes. Given APRA’s transition arrangements for bank hybrids those conversations are better started sooner rather than later. From 1 January 2027, APRA’s revised framework takes effect; existing bank AT1 instruments receive transitional Tier 2 treatment until their first scheduled call dates (no later than 2032). A call or redemption is not guaranteed. 

Which objections still matter? 

Of the six objections, three have changed materially. The research burden for investment-grade bonds is lower than many advisers assume, diversification can now be achieved more easily through fractional access, and scaling challenges are largely operational problems with established solutions. 

Two objections are mostly administrative. Pricing transparency has improved significantly and approved-product-list hurdles are generally matters of process rather than investment merit. 

One remains genuinely important: liquidity. Where bond capital may be required at short notice and at a known value, maturity-based strategies are often the wrong tool. The same applies to sub-investment-grade credit, where specialist analysis and broader diversification remain essential. 

The advisers best prepared for the post-hybrid environment will not be those who view direct bonds as either simple or impossible. They will be those who understand which objections still apply to the client sitting in front of them, and which no longer do. 

Every practice approaches fixed income differently. To discuss whether direct bonds may be appropriate for your clients, portfolio models or investment process, please contact AUSIEX Fixed Income at martin.smith@ausiex.com.au. 

 

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This information has been prepared by Australian Investment Exchange Limited (AUSIEX) (ABN 71 076 515 930, AFSL 241400), a wholly owned subsidiary of Nomura Research Institute, Ltd. (NRI). AUSIEX is a Market Participant of ASX Limited and TMX Australia Exchange Pty Limited (TMX), a Clearing Participant of ASX Clear Pty Limited and a Settlement Participant of ASX Settlement Pty Limited.

AUSIEX Fixed Income is provided under the Australian Financial Services Licence of FIIG Securities Limited (FIIG) (ABN 68 085 661 632, AFSL 224659). FIIG is a wholly owned subsidiary of AUSIEX.