By SmartAsset Team

An investor looking up how to invest in covered bonds.

Covered bonds are a type of debt security issued by financial institutions and backed by a pool of high-quality assets, such as mortgages or public-sector loans. This means that investors are safeguarded by both the issuing bank and the underlying asset pool. This additional layer of security, known as a dual recourse structure, makes them a popular choice for conservative investors seeking capital preservation and steady returns. If you’re interested in adding covered bonds to your portfolio, a financial advisor can help you determine how they could align with your general investment strategy and risk tolerance.

What Are Covered Bonds?

Covered bonds are secured debt instruments which offer greater investor protection than traditional corporate or government bonds. Known as a dual recourse structure it provides two layers of protection:

  1. The issuing bank or financial institution. The bank remains responsible for repaying the bond, even if the underlying assets underperform.
  2. The cover pool of assets. If the issuing bank defaults, the underlying asset pool is used to repay bondholders.

Unlike mortgage-backed securities (MBS), where the risk is transferred entirely to investors, covered bonds keep the issuing bank accountable for maintaining asset quality. This structure makes covered bonds one of the safest fixed-income investments. 

Here are four key features of covered bonds:

  • Regulatory oversight. Covered bonds are governed by strict regulations in most countries, ensuring their safety and transparency.
  • Overcollateralization. The cover pool of assets often exceeds the bond value, providing extra security for investors.
  • No direct ownership of underlying assets. Unlike mortgage-backed securities, investors do not directly own the assets in the cover pool.
  • Liquidity and stability. Covered bonds are actively traded in European markets and offer consistent returns with low volatility.

The market for covered bonds is well-established in Europe, particularly in Germany, France and the UK, where they are a key component of the financial system. In the United States, covered bonds remain a relatively niche investment, but have gained interest among institutional and conservative investors.

Covered Bonds vs. Other Types of Bonds

While covered bonds share similarities with traditional bonds, they have unique characteristics that differentiate them from other fixed-income securities:

  • Covered bonds vs. corporate bonds: Corporate bonds are generally unsecured, meaning investors rely solely on the issuing company’s creditworthiness. 
  • Covered bonds vs. mortgage-backed securities (MBS): Mortgage-backed securities transfer risk to investors, whereas covered bonds keep banks accountable, reducing potential losses for bondholders.
  • Covered bonds vs. government bonds: Government bonds are backed by the government’s credit rating, while covered bonds are backed by private financial institutions and secured by high-quality assets.

How to Invest in Covered Bonds

An investor researching the benefits of covered bonds.

To invest in covered bonds, you can buy them through a brokerage firm or directly from issuing banks. But before investing, you should assess the creditworthiness of the issuing institution and understand the specifics of the underlying asset pool. Here are four general steps to help you get started.

1. Research Covered Bonds in the Market

Covered bonds are widely available in European, Canadian, and select U.S. markets. Be sure to research the different covered bond programs, their underlying asset pools and credit ratings before investing. Agencies such as Moody’s, S&P, and Fitch provide credit ratings for covered bonds based on the issuing bank’s financial health and asset backing. Most covered bonds have AAA credit ratings, but it’s still important to assess the issuing bank’s financial strength and the bond’s regulatory framework.

2. Choose an Investment Method

Covered bonds can be purchased in several ways:

  • Through bond markets: Institutional investors can buy covered bonds directly from international bond markets.
  • Via mutual funds and ETFs: Some bond mutual funds and exchange-traded funds (ETFs) include covered bonds in their portfolios, allowing retail investors access without purchasing individual bonds.
  • Through brokerage accounts: Certain brokerage firms offer access to covered bonds, particularly in European markets.

3. Assess Yield and Interest Rate Sensitivity

Like other bonds, covered bonds provide fixed or floating interest rates. Investors should compare yields, maturity terms and interest rate trends to determine which bonds fit their investment portfolio. Longer-term covered bonds may offer higher yields, but are more sensitive to interest rate changes.

4. Diversify Within Fixed-Income Holdings

Covered bonds can complement government bonds, municipal bonds and corporate bonds in a diversified portfolio. Investors should balance their bond allocations based on risk tolerance, expected returns, and interest rate outlooks.

Benefits of Investing in Covered Bonds

If you’re thinking about investing in covered bonds, here are six common benefits to consider:

  • High credit quality. Covered bonds are typically issued by financially strong banks and backed by low-risk asset pools, reducing the risk of default.
  • Dual recourse protection. Investors have the security of both the issuing bank and the cover pool, offering an additional layer of safety.
  • Steady and predictable returns. Covered bonds provide consistent interest payments, making them ideal for income-seeking investors.
  • Low default rates. Historically, covered bonds have extremely low default rates, making them a safer alternative to corporate bonds.
  • Diversification benefits. Adding covered bonds to a portfolio helps diversify risk while maintaining stable returns.
  • Regulatory protections. Many jurisdictions enforce strict regulations on covered bonds, ensuring transparency and investor protection.

Bottom Line

An investor thinking about covered bonds and other investments.

Covered bonds are an attractive fixed-income investment offering safety, reliability and strong investor protection as a lower-risk alternative to corporate bonds and mortgage-backed securities. While covered bonds are more commonly found in European and Canadian markets, investors in the U.S. can gain exposure through bond funds, ETFs and brokerage firms offering international bonds.

Investment Planning Tips

  • A financial advisor can help you analyze investment options and manage risk for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you want to diversify your portfolio, here’s a roundup of 13 investments to consider.
  • And, if you want to know how much you could pay in taxes for the sale on an investment, SmartAsset’s capital gains calculator can help you get an estimate. 

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