Fixed Income Investing: Explore a spectrum of solutions
What is fixed income?
Fixed income plays a crucial role in investment portfolios by offering potential outcomes including regular income and diversification from stocks (or ‘equities’). Some areas of fixed income may also offer attractive returns.
Investing in fixed income commonly means buying securities called bonds. Bonds are effectively a type of loan issued by governments or companies when they need to raise money, say to fund a project or manage cashflows.
The loan is taken out for a pre-determined period-of-time, during which the lender – or bond holder – will usually receive a fixed rate of interest, paid at regular intervals in what’s known as coupons. At the end of the agreed period (‘maturity’) the original amount borrowed is repaid in full.
A fixed income fund may offer an efficient means of investing in a range of bonds from diverse issuers.
Understanding fixed income
Traditionally seen as the low risk portion of a portfolio, today’s fixed income markets may offer a broad choice of outcomes to meet different financial goals.
This is important in a low interest rate environment like we have today, where cash deposits and traditional safe-haven bonds such as those issued by developed market governments may not be paying adequate levels of interest or income to combat inflation.
Although fixed income seems complicated, there are essentially two ways in which investors use bonds to make money. The first is regular income generation from the potential coupon payments. The other is aiming to generate capital return by selling the bond before maturity to another investor for a higher price than originally paid, much as you would with equities. Bonds ‘market’ prices tend to fluctuate less than equity prices but can be similarly affected by supply and demand, as well as some specific factors described in the next section.
Because the price of a bond can move, so can the value of the income, referred to as ‘yield’. Yield is calculated as a percentage by dividing the coupon payment amount by the price of the bond (e.g. a bond priced at $1 paying a coupon of 5p has a yield of 5%). As the price can move but the coupon is fixed, the yield will move (inversely) with the price.
Fixed income risks
Comparing fixed income versus equities still tends to show the former as a lower risk option overall. However, fixed income seek to provide opportunities across the risk/reward spectrum to position portfolios for different environments and generate varying levels of income and potential return.
Interest rate risk
Bond prices usually move in the opposite direction to interest rates, so when rates are rising, bond prices may fall, and vice-versa. This is because bonds are riskier than cash, so investors need the incentive of higher rewards to use cash to buy bonds. When interest rates are low, demand for bonds is higher which pushes up prices – and vice-versa.
There is a risk that the issuer of the bond will default on its debt by failing to pay investors what it owes them. This risk varies with the credit-worthiness of the issuer and is reflected in their credit rating. Investors who take more risk by investing in lower rated issuers have the potential to achieve higher reward, and vice-versa. Issuers with a higher credit rating are considered ‘investment grade’ while those with a lower credit rating are considered ‘high yield’.
Liquidity risk is a measure of how quickly an investor could turn an asset into cash, if they needed to. In market environments where liquidity is low there is a risk that if a bond holder wanted to sell the bond, they may have difficulty finding a buyer, especially at a good price.
Inflation – the rate at which the prices of goods and services increases – can be a risk if the level of inflation is higher than the level of income made on savings and investments. The income paid by bonds is fixed so when inflation is rising, that level of income may be less appealing and bond prices tend to fall - and vice-versa.
A range of options to help investors reach their financial goals
Invest for a conservative profile
In an uncertain and low interest rate/low yield environment, cautious investors looking to put cash to work might consider bonds that have a shorter life span, known as ‘short duration bonds’. While not risk-free, the potential reward is a more attractive return than cash while minimising exposure to risk and the impact of market volatility.
Invest for Total Return
For investors seeking moderate capital growth and income, an unconstrained approach offers the potential to be opportunity-driven across the full fixed income landscape. Freedom to respond to the market environment, rather than following a benchmark, puts the focus on achieving a return target for a given level of risk.
Invest for Capital Growth
Investors who are willing to take on more risk can reach further to aim for higher rewards. High yield bonds offer the potential for enhanced income and equity-like long-term return potential, generally with lower volatility than equities. They can also provide good diversification for other fixed income assets. Investors can aim to manage the risks through diversification, careful security selection and ongoing monitoring.
Why AXA IM for Fixed Income Investing?
We believe the key to superior long-term returns in the fixed income market is compounding current income and avoiding principal loss. We have extensive experience of managing fixed income portfolios through a succession of economic cycles.
At the heart of our investment approach lies a robust, repeatable, global investment process, focused on the monitoring of risks. We understand credit, interest rate, inflation, liquidity and market risk and, where possible, manage against these risks in an effort to deliver consistent performance to our clients.
We focus on harnessing our significant global resources to combine views across macro-economic research and bottom-up, company insights – including on Environmental, Social & Governance issues. This research is the foundation on which we build and actively manage portfolios aiming to navigate the increasingly complex fixed income market environment while delivering against our clients’ objectives.
Investors are facing an environment where traditional sources of income, such as mainstream government bonds, may no longer by themselves offer sufficient levels of income to meet financial goals. Combined with increasing economic uncertainty and ongoing market volatility, this presents a significant challenge. We believe one solution could be to look further out across the fixed income spectrum at the diverse and versatile opportunities on offer.
At AXA-IM, our fixed income expertise covers capabilities across a the fixed income universe. Our strategies span developed and emerging markets, government and corporate debt, and investment-grade and high-yield markets. We have active benchmark-relative strategies in the major fixed income sectors and flexible, unconstrained strategies that aim to deliver performance with a low correlation to both interest rate and credit risk. We also offer buy and maintain strategies that aim to provide an answer to the challenge of market illiquidity. This means clients can choose from fixed income strategies focused on specific sectors, regions or outcomes depending on their risk tolerance and goals, backed by our extensive global expertise.
*Assets under management after delegation to the other asset classes as 31-03-2020(AXA IM Database)
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How a bond’s price responds to changes in interest rates is measured by its duration but its limitation is that it incorrectly assumes a linear relationship between bond prices and yields.
Everything about duration: Interest rate risk
Two of the key risks in fixed income investing are credit risk and interest rate risk. Changing interest rates are very important to bond investors as there is a close but inverse relationship betwee ...
Everything about duration: Yield shifts
Yield curves plot interest rates (‘yields’) of bonds of equal credit rating and different maturities.