Fixed income: 10 things you should know

Schroders
Simon Doyle
Simon Doyle
Schroders Head of Fixed Income and Multi-Asset
0
Many investors invest in fixed income investments as part of a diversified portfolio – but what is it all about?

1. Fixed income – also known as bonds and credit – is a commonly used type of debt investment. It is a type of ‘asset class’, meaning a category of asset into which an investor can invest.

2. Bonds are issued by governments or corporate entities seeking to raise funds. The issuer (also known as the borrower) sells a bond to an investor (also known as the lender) and the issuer promises to pay the principal back at the bond’s maturity date and to make regular fixed interest payments (called coupons), typically twice a year until (and including on) the final maturity date.

3. Types of bonds include:

- Government bond: issued directly by a government such as the Australian Commonwealth Government and guaranteed by the issuing government.

- Corporate bond: issued by large public companies to fund business growth or significant projects, or corporate actions (like a takeover). Corporate bonds do not carry a government guarantee, so they are generally riskier than Government bonds as there is increased credit risk (the risk the issuer will default on payment of coupons and principal). Due to this risk corporate bonds usually pay higher coupons than government bonds.

- SSA (Semi-government, Supranationals and Agencies) bonds: issued by entities such as State governments (for example, NSW issues debt through the state government guaranteed entity the NSW Treasury Corporation), semi-Government organisations (entities owned by a government with either an explicit or implicit government guarantee), and Supranationals (entities that are sponsored or supported financially by a group of two or more national governments, for example, the World Bank and European Development Bank).

- Hybrid: an investment that exhibits characteristics of both fixed income securities and equities. For example, convertible bonds start as bonds but can be converted into equity at a future date. These types of securities typically carry more risk than corporate bonds as they rank lower in the capital structure than corporate bonds. If the issuer defaults on repaying the loan, investors in hybrids will only receive their money back after other security holders – higher up the chain – have received their money.

4. Some common terms relating to fixed income include:

- Coupon: the annualised interest rate that is paid (typically semi-annually) on the face value, expressed as a percentage.

- Credit rating: given to bonds and other debt investments by ratings agencies such as Standard & Poor’s or Moody’s on the basis of their risk. The scale ranges from AAA (the highest) through to C or D, depending on the agency. The top 4 ratings are considered safe, or ‘investment grade’, while lower ratings (BBB for Standard & Poor’s and Baa3 for Moody’s) are known as ‘high yield’ or ‘sub-investment grade’. In general governments have higher credit ratings than companies, reflecting that government debt is typically less risky (which causes it to typically deliver lower rates).

- Duration: a risk metric that describes how sensitive a bond is to a change in market yields. For example, a bond with a duration of 6 years will increase in value by 6% for every 1% fall in the market yield. Conversely the value will fall by 6% for a 1% rise in market yields. Maturity and duration are linked, with longer maturity bonds having higher duration and therefore being more sensitive to changes in market yields.

- Face value: the amount received at maturity.

- Maturity: the pre-set date at which the face value and final coupon is paid.

- Yield: the annualised return of the bond at its current price.

- Yield to maturity: the total return expected from a bond if the bond is held until its maturity date, and all payments are made as planned and reinvested at the same rate.

5. Many investors use fixed income (particularly government-issued bonds) as a ‘defensive’ investment because it can help preserve capital, usually experiences less return volatility than shares and can pay a steady income stream through its regular coupon payments. It is viewed as lower risk than other asset classes such as equities and listed property.

6. Bonds can offer diversification benefits because they often perform well when shares perform poorly, which means that bond investments help to lower total risk within a diversified portfolio.

7. The total return on bonds comprises income from coupon payments plus any growth or loss from price fluctuations. The price or value of a bond, with fixed coupon payments, increases as the yield-to-maturity declines and vice versa.

8. The Australian bond market (government and corporate issues) is worth $958 billion1 in Australian dollars, while globally the bond market is worth $167 trillion Australian dollars2.

9. You can access bonds directly or through a managed fund. The benefit of a managed fund is that it can hold hundreds, sometimes thousands, of securities which allows it to achieve significantly higher diversification than most individual investors. This means that if there is a default on one security, the impact on the investor is lessened given the high number of other securities held in the portfolio.

10. The Schroder Fixed Income Fund provides a cost-effective way of accessing a highly diversified portfolio of bonds, which can include a mix of Australian or international government and corporate bonds, or a combination of both.


1 Source: Australian Securities Exchange (ASX) Bond Monthly Update – December 2020.

2 Source: International Capital Market Association (ICMA) Bond Market Size as at August 2020. Note the figure quoted by this organisation is in US Dollars and has been converted to Australian dollars using the exchange rate of 1 AUD = 0.7645 USD sourced from the Reserve Bank of Australia as at 29/1/21.

Important Information:
This material has been issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders) for information purposes only. It is intended solely for professional investors and financial advisers and is not suitable for distribution to retail clients. The views and opinions contained herein are those of the authors as at the date of publication and are subject to change due to market and other conditions. Such views and opinions may not necessarily represent those expressed or reflected in other Schroders communications, strategies or funds. The information contained is general information only and does not takeinto account your objectives, financial situation or needs. Schroders does not give any warranty as to the accuracy, reliability or completeness ofinformation which is contained in this material. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this material or any other person. This material is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. You should note that past performance is not a reliable indicator of future performance. Schroders may record and monitor telephone calls for security, training and compliance purposes.

Learn more
Established in 1961, Schroders in Australia is a wholly owned subsidiary of UK-listed Schroders plc. Based in Sydney, the business manages assets for institutional and wholesale clients across Australian equities, fixed income and multi-asset and global equities.

Schroders believes in the potential to gain a competitive advantage from in-house global research; that rigorous research will translate into superior investment performance. We believe that internal analysis of investment securities and markets is paramount when identifying attractive investment opportunities. Proprietary research provides a key foundation of our investment process and our world-wide network of analysts is one of the most comprehensive research resources dedicated to funds management.

Areas of expertise:
Australia equities
Fixed income
Multi-asset
Global equities

Why Schroders?

With a global network of researchers, we focus on serving our clients and targeting one result - superior investment performance.

Inherent in our approach to investment management is:
A structured, disciplined and repeatable investment process
A clearly defined investment style
A team approach to investment management

A global asset manager

We have responsibility for A$803.1 billion of assets* on behalf of institutional and retail investors, from around the world. Their assets are invested across equities, fixed income and alternatives.

We employ over 4700 people worldwide who operate from 41 offices in 30 different countries across Europe, the Americas, Asia and the Middle East.

We are close to the markets in which we invest and our clients.

Schroders has developed under stable ownership for over 200 years. Long-term thinking governs our approach to investing, building client relationships and growing our business.

*Source: All data as at 30 June 2018