Australian Fixed Income

Fixed income can help diversify a portfolio, reducing volatility when compared to growth assets like property and shares, while providing a higher return than cash. Fixed income can also provide a regular income with relatively low risk and high liquidity.

Fixed income funds own securities selected by a professional fund manager. Most bonds pay interest, or ‘coupons’, enabling funds to make regular distributions to investors.

While all investments carry risk, fixed income is considered a defensive asset class, and typically carries less risk than growth assets like property and stocks. There is a spectrum of risk within fixed income; from the safest government bonds through to high yield corporate bonds. A professional investment manager can help manage fixed income risk through diversification strategies and careful issuer selection.

Growth assets are higher risk investments such as property, alternatives and shares, which tend to offer investors a higher return.

Defensive assets are lower risk investments such as cash and fixed interest, which tend to offer investors a lower return over the long term.

There are three major ratings agencies – Moody’s, Standard & Poor’s (S&P) and Fitch – that assess and publish views on bond issuers’ creditworthiness. Bonds are assigned ratings between AAA, the most financially secure, and D. Higher rated bonds are considered investment grade, while bonds with ratings that fall below BBB or Baa3 are considered high yield bonds.

A bond is essentially a loan between an investor and an issuer, and is the most common form of fixed income. Fixed income can also refer to a broader spectrum of instruments that also operate on a fixed schedule of interest and principal repayments, such as mortgage-backed securities and bank loans. Fixed income funds are commonly referred to as bond funds.

A coupon is the annual interest earned from a bond based on its face value.

Any investment where an issuer must repay a loan to an investor is considered fixed income. Fixed income assets such as government and corporate bonds require a borrower to repay the loan with interest in agreed increments. Fixed income can also include term loans, convertible notes and commercial mortgages.

A convertible note is a type of fixed income that converts into equity, rather than repaying investors with the principal plus interest. For example, an investor may loan money to a business and receive equity in that business at the maturity of their loan.

All investments carry risk. While fixed income is considered a defensive asset class, there is a small chance that issuers may default on bonds, be unable or unwilling to make regular interest payments or fail to repay the value of the bond at maturity. While uncommon, defaults can result in permanent capital impairment. This underlines the value of diversification and having bond exposures managed by a professional investment manager.

Borrowers that issue higher yielding bonds typically have a higher perceived risk of defaulting on repayments. As a result, yields on high yield bonds are typically higher than comparable investment grade securities – effectively compensating investors for the higher risk. Economic conditions and interest rate levels may also impact significantly on the value of all bonds, including high yield issuers.

The issuers of bonds or similar investments may not be able to meet their interest payments or repay their debt, which could lead to capital impairment. The risk may be greater for investments in bonds with low or no credit rating.

Portfolios can be positioned to benefit from anticipated directional movements in bond yields. Changes in economic conditions and interest rate expectations typically affect bond yields.

A yield curve is an expression of market sentiment – specifically expectations of future bond yields. When similar securities with varying maturities are plotted on a line graph, a yield curve forms. We can position portfolios to benefit from anticipated movements in the shape of bond yield curves, both within Australia and in selected overseas markets. Yield curves rarely remain static for long and movements provide opportunities for active managers to exploit.

A yield curve is an expression of market sentiment – specifically expectations of future bond yields. When similar securities with varying maturities are plotted on a line graph, a yield curve forms. Under normal interest rate conditions, a yield curve is upward sloping with yields on longer-dated securities higher than those on shorter-dated notes. This reflects the fact that the future is uncertain. Investors holding longer-dated bonds are therefore typically rewarded with higher yields to compensate for the higher risk.

A yield curve is an expression of market sentiment – specifically expectations of future bond yields. When similar securities with varying maturities are plotted on a line graph, a yield curve forms. When short-term interest rates are higher than longer term interest rates, the yield curve is downward sloping, or ‘inverse’. Movements in monetary policy and volatility can both cause short term interest rates to rise.

Inflation refers to an increase in the prices of goods and services. Inflationary pressures impact various investments, including inflation-linked bonds. Some of our bond funds are able to implement active positions in this area of the market to benefit from anticipated trends.

Some of our portfolios are able to benefit from movements in global government bond markets relative to one another. Positions can be established to capture anticipated outperformance of Australian bonds relative to the US counterparts, for example, or vice versa.

Hedging transactions are designed to reduce, insofar as possible, currency risk for investors. However, there is no guarantee that the hedging will be totally successful and no hedging strategy can eliminate currency risk entirely.