)
Bonds explained: fundamentals and functions of bonds in Switzerland
Bonds are one of the key investment instruments in the Swiss financial market. They offer private investors a relatively secure and predictable return. As a core component of a well-balanced portfolio, bonds have regained appeal following recent interest rate developments.
What are bonds?
A bond (also known as a fixed-income security) is a debt instrument. Investors lend money to the bond issuer (the so-called debtor) for a set period and receive interest payments (coupons) along with the repayment of the invested capital at the end of the term.
Bonds are considered debt capital: as creditors, investors have a contractual right to interest and repayment but no voting rights in the issuing entity. In contrast, shares represent equity capital: purchasing a share means acquiring a stake in a company, participating in profit growth, having voting rights, and accepting a higher level of risk.
The creditworthiness of the issuer plays a key role in determining the potential returns and risks of a bond. Highly rated issuers (such as the Swiss government) can raise capital at lower interest rates because the risk of default is minimal. Issuers with weaker credit ratings must offer higher interest rates to attract investors willing to take on more risk. The general rule is: the higher the interest rate, the greater the potential default risk.
The Swiss bond market
The Swiss bond market operates under similar principles to those in other countries, but it is embedded in Switzerland's specific financial landscape, which is characterised by strong monetary stability, a history of banking confidentiality, and highly rated public issuers.
Common bond issuers in Switzerland include:
The Swiss Confederation (government bonds)
Cantons and municipalities (e.g., for infrastructure projects)
Large corporations (corporate bonds)
As an investor, you are essentially lending money and, in return, receiving regular interest payments and the repayment of the principal at the end of the bond's term. Bonds can also be sold on the SIX Swiss Exchange before maturity. The market price of bonds is influenced by interest rate movements: when market interest rates rise, existing bond prices fall; when rates decline, bond prices rise. However, if you hold a bond until maturity, you will receive the full face value, meaning short-term price fluctuations become irrelevant.
Types of bonds and their characteristics
Bonds come in various categories, differing in terms of maturity, interest rates, risk levels, and purpose. Each type serves different needs for issuers and investors.
The most common types of bonds:
Government bonds: Issued by governments to finance public spending. Swiss government bonds are considered extremely safe due to Switzerland’s top-tier credit rating. The risk is minimal, and accordingly, the coupon payments are low. Government bonds from major industrialised nations are often seen as a "safe haven" in times of crisis. However, not all government bonds are equally secure—some countries with unstable finances have defaulted in the past, highlighting the importance of issuer creditworthiness.
Corporate bonds: Bonds issued by companies. The risk and return of corporate bonds depend on the financial strength of the issuing company. Established firms with strong credit ratings offer moderate interest rates, while smaller or less creditworthy companies must offer higher coupons to compensate for their higher default risk. Investors seeking higher returns than those available from government bonds may consider corporate bonds, but they should be aware of the potential risk of financial difficulties or defaults.
Convertible bonds: A special type of bond that grants the right to convert the bond into shares of the issuing company at a later stage. This is advantageous for companies, as it allows debt to be transformed into equity if the business performs well. Investors receive fixed interest payments and the opportunity to benefit from potential share price increases. However, the coupon is usually lower than that of traditional corporate bonds—the "price" for the conversion option. Convertible bonds are ideal for investors who believe in a company’s growth potential but still want the security of fixed interest payments.
Other bond types include:
Cash bonds: Issued by Swiss banks, similar to fixed-term deposits. They have maturities of 2 to 10 years with fixed interest rates, are not traded on the stock exchange, and often offer higher yields than savings accounts, though with reduced liquidity.
Mortgage bonds: Bonds secured by real estate, typically issued by mortgage institutions.
High-yield bonds (junk bonds): Issued by companies with lower credit ratings, offering higher interest rates but carrying greater risk.
For private investors, understanding the relationship between risk and return is crucial: safer bonds, like Swiss government bonds, provide lower returns, whereas riskier bonds promise higher yields but come with a greater chance of default.
The choice of bond types depends on the investor's profile: risk-averse investors prefer government bonds and high-quality corporate bonds, while return-focused investors with a higher risk tolerance may opt for high-yield or convertible bonds.
Advantages and disadvantages of investing in bonds
Like any asset class, bonds come with pros and cons:
Advantages
High security and stability: Compared to shares, bonds generally experience lower price fluctuations. Government bonds and bonds from highly rated issuers are considered very secure. This makes them a stabilising component in a portfolio, particularly useful for cushioning stock market losses during crises.
Predictable returns: Bonds provide fixed interest payments, typically annually or semi-annually. These regular earnings offer a degree of certainty, allowing investors to plan their finances in advance. The transparency of bond terms simplifies financial planning.
Capital repayment at maturity: Investors receive the full face value of the bond upon maturity, provided the issuer remains solvent. This contractual repayment obligation offers clarity—unlike shares, which have no fixed redemption date.
Portfolio diversification: Bonds are relatively independent of stock market performance and can help diversify an investment portfolio. When share prices fall, bonds often remain stable or even rise, acting as a counterbalance. Many financial experts recommend holding bonds as a core element of a diversified portfolio to reduce risk.
Disadvantages
Limited return potential: Unlike shares, bond returns are capped. Investors receive only the agreed interest payments and the nominal value at maturity—no dividends or price gains beyond that (unless traded before maturity). As a result, long-term bond returns tend to lag behind shares.
Interest rate risk: Fixed-interest securities are sensitive to changes in market interest rates. When interest rates rise, existing bond prices fall because new bonds offer higher coupons. Conversely, when rates decline, bond prices increase. This interest rate risk is especially relevant for investors who may need to sell before maturity, as they could face losses.
Inflation risk: Fixed bond interest payments can lose purchasing power due to inflation. If inflation surpasses the coupon rate, the real return diminishes. This is particularly concerning for long-term bonds, where inflation can significantly erode value over time.
Credit risk: While top-rated issuers rarely default, corporate bonds and lower-rated issuers carry real credit risk. If an issuer experiences financial difficulties, they may suspend interest payments or fail to repay capital. Investors should assess credit ratings before investing, and diversifying across multiple issuers can help mitigate default risk.
Lower liquidity: Some bonds (such as cash bonds or those from smaller companies) are less liquid, meaning they cannot always be sold at a fair price on short notice. For investors requiring flexibility, this can be a drawback.
No voting rights and limited participation: Bondholders have no say in company decisions and do not benefit from capital appreciation beyond fixed interest payments. Investors looking for greater participation in corporate success should consider shares instead.
Debt financing vs. equity financing from a corporate perspective
Larger, well-established companies often use bonds to raise capital without diluting ownership. Smaller firms, on the other hand, tend to rely on equity financing, as issuing bonds is often too costly or not feasible in sufficient volumes. This explains why the bond market is predominantly dominated by governments and large corporations.
Conclusion: bonds as a key part of a balanced portfolio
For private investors, bonds are a fundamental tool for greater portfolio stability. As debt instruments, they effectively make investors lenders, entitling them to interest payments and capital repayment. These relatively secure investments—especially those issued by highly rated entities like the Swiss Confederation—offer predictable returns and help reduce reliance on volatile stock markets.
In a diversified portfolio, bonds can cushion fluctuations in other asset classes. The optimal allocation depends on your individual goals, risk tolerance, and investment horizon. With this foundational knowledge, you can assess the role bonds should play in your personal investment strategy.
Want to learn more?
Alpian’s financial experts are happy to answer your questions and help you build a tailored investment strategy, ensuring you invest in bonds and other asset classes with confidence.
