Do you get confused when it comes to the different types of instruments that make up your investment portfolio? And what are the benefits and drawbacks of the ‘safer’ and ‘steadier’ style of fixed interest or fixed income investing in today’s uncertain investment climate?
Our Fixed Income Committee at Canaccord Genuity Wealth Management will bring fixed income investing to life over the next couple of months –with a series of blogs and ‘explainer videos’ on fixed income investing – developing your knowledge about investing in bonds, from the bottom-up. We’ll strip it back. What it is, who’s it for and how we work in this space?
What is fixed income investing?
Typically, a fixed income investment provides a fixed amount of income annually to the investor; usually a fixed percentage of the amount invested. The largest sector of the fixed income market is made up of bonds either issued by governments (Gilts or US Treasury Bonds) or by companies (corporate bonds). In a typical diversified investment portfolio, an investor would have exposure to the main asset classes: equities, bonds, alternative investments and cash. A large majority of bonds can be bought or sold daily by your investment manager.
Who are fixed income investors?
The type of investors that favour large portions of their portfolio to be in fixed income investments are typically retired individuals who rely on their investments to provide a regular, stable income stream.
Why should I invest in fixed income and hold bond investments?
There are many reasons you should hold bond investments in your portfolios – these include:
- To diversify your portfolio to reduce the volatility of returns (and thereby the risk) by investing across asset classes
- To generate a steady income stream
- To potentially produce capital gains
- To make use of the fixed annual income to offset fixed liabilities.
Fixed income investing – what to know as a savvy bond investor
Are there different types of bonds? When investing in bonds, it is a mistake to view all bonds in the same way. The risk, return and role they play in your portfolio can vary greatly depending on the characteristics of the bond and the reason the bond was originally purchased. For example, some bonds are considered high quality (lower risk – lower return) – such as bonds issued by governments or blue chip companies, whereas other bonds are regarded as lower quality (higher risk – higher return) such as bonds issued by companies whose ability to pay interest and repay the capital at maturity is less reliable.
How long does a bond ‘lifetime’ last?
Bonds are basically loans or ‘debt’ instruments which typically have a specified life of duration – for example, 1 month to 30 years. They usually pay a set amount of annual income to you – the coupon.
Why are bonds generally considered a lower risk investment instrument?
Bonds generally rank higher than equities on a company’s balance sheet and, in case of liquidation, the recovery potential for a bond investor is greater than an equity investor. The performance of bonds also tends to have a low correlation to equity returns. This means that fixed income investments diversify your portfolio.
How can I tell the difference between how bonds are rated?
Being debt instruments, bonds are risk rated by their ‘credit rating’. They are rated from AAA (highest) to D (lowest). Investment grade bonds, the higher quality companies, are rated from AAA to BBB and sub-investment grade (higher yield) are rated BB to D.
What are the main factors that affect the price of bonds?
The main things that affect a bond’s price are:
- The direction interest rates are moving (interest rate risk)
- The perceived risk associated with the issuer (credit risk)
- The amount of time left before the issuer has to repay the bond holder (duration risk).
Shorter dated bonds – those that will redeem within five years – are less price-sensitive to interest rate movements than longer dated bonds.
What is the difference between ‘higher’ and ‘lower’ quality bonds?
Higher quality bonds are more interest rate sensitive and will decline in price as interest rates rise. Lower quality bonds tend to be less interest rate sensitive and more sensitive to the economic climate. If times are prosperous, they are more able to make interest payments and repay bond holders when the bond reaches its maturity date.
Where do the challenges lie when it comes to fixed income investing in the current economic climate?
When we meet as the Fixed Income Credit Committee at Canaccord Genuity Wealth Management, we set out to find bonds for our clients which we think will be resilient in the current economic environment. We currently think interest rates will rise and that economic growth is sustainable; so we look for bonds issued by cyclical companies whose businesses are healthy and growing and those companies who were under pressure during the economic slump but where we have identified an improving trend. This type of bond should be less sensitive to rising interest rates and supported by improving economic conditions.
Why not watch the video to find out more about how our fixed interest committee works?
Your capital is at risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.