The fixed income asset class covers a broad range of investments: deposits, bonds, hybrids and securitised investments such as asset backed securities and residential mortgage backed securities.
Eight reasons to consider investing in some of the fixed income securities listed above:
- Diversification – you can access governments, companies and investments that you can’t find anywhere else. For example, government bonds are great diversifiers as they are not tied to the economic cycle. Private companies, not listed on the ASX, issue bonds and large international companies issue Australian dollar denominated bonds removing currency risk, such as Apple and BMW. Investors can also access foreign currency bonds.
- Reliable income – Deposits and bonds pay reliable income, known at the outset of the investment. Hybrids also have a known income payment, but this can be missed under certain circumstances. Whereas dividends on shares can be cut, and income on property reduced due to repairs and maintenance – or lost if the property is vacant.
- A maturity date – Deposits and bonds have a defined maturity date, so you never have to decide to sell the investment. If you are setting up a portfolio for a less financially aware spouse, they do not have to be concerned about timing the market or making the decision to sell.
- Liquidity – Savings accounts are liquid as are the very lowest risk, highest quality bonds. In stressed markets, growth assets and higher risk investments can become illiquid, fixed income investments can then provide much needed liquidity.
- Access to a very wide range of risk and return investments – The highest quality Australian Commonwealth Government Bonds (ACGBs) are considered ‘zero risk’ investments as the government raises taxes and prints money. State government and territory bonds are very low risk. At the other end of the scale, sub-investment grade, high yield bonds offer attractive, higher income but come with higher risk.
- An opportunity for capital gain or loss – Once a bond is issued in the market at its $100 face value, it is then available to trade and the price of the bond goes up and down. Investors that sell bonds before maturity can make a gain or loss, depending on the price of the bond. Equally, investors can buy bonds in the secondary market trading at a discount and if the price rises or they hold the bond to maturity, can achieve a greater than expected return.
- To hedge or take advantage of interest rate risk – Fixed rate bonds pay a fixed rate of income over the term of the security. The only way they can show changes in interest rate expectations is through the price of the bond. Lower interest rates will force fixed rate bond prices up, while higher interest rates will force fixed rate bond prices down. Investors that do not want to take interest rate risk can invest in floating rate bonds, where interest income is tied to a benchmark such as the Bank Bill Swap Rate (BBSW). Interest income on these bonds is adjusted quarterly, so takes minimal interest rate risk.
- To hedge inflation – Inflation-linked bonds are the only direct hedge against inflation. Capital indexed bonds are tied to the Consumer Price Index (CPI), and interest income is adjusted quarterly.