FIXED INCOME EXPLAINED

Here is our quick start guide to investing in fixed income.

Bonds – also known as fixed income – are essentially an IOU. Governments and companies borrow money when they issue bonds, then promise to repay it at the end of the bond’s life. A bond exchange-traded fund (ETF) is a collection of bonds that trades on an exchange, like stocks do.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

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Introduction to bonds

When a government, public authority or company wants to raise money, what does it do? One option is to issue fixed-income securities, or bonds.

These bonds are bought by investors, who receive a set interest payment each year, as well as repayment of the bond’s face value at a pre-arranged date. This date is known as the bond’s maturity.

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Why does bond maturity matter?

You can buy bonds with all kinds of maturity dates – ranging from a few months to many years. Bonds with longer maturity dates – say 20 years from now – are considered riskier than shorter bonds. This is because it is difficult to know what the economy will look like in the future. Long-term bonds tend to pay a higher interest rate because the bond holder is more exposed to interest rate and inflation risks.

 


Why investors pick bonds

Who issues bonds?

It’s not just governments that issue bonds – companies issue them too. The governments of countries like the UK and US have a good track record when it comes to repaying their bonds. These bonds are considered less risky than bonds issued by companies. Corporate bonds tend to pay more interest, to compensate the buyer for the risk of loss.

 


Why investors pick bonds

What is the value of a bond?

When valuing a bond, we consider its yield. Expressed as an annual percentage, the yield considers the bond’s purchase price and the interest payments expected over its life. A few other factors affect the yield, such as interest rates and the creditworthiness of the issuer. Riskier bonds have higher yields.

 


Why investors pick bonds

  • Including bonds in your strategy increases diversification, which makes your portfolio more resilient. This is particularly relevant to investors who increased their stock exposure in recent years in response to low interest rates.

    Diversification explained

    A diversified portfolio is one that spreads risk by investing in various assets, such as bonds and equities. The key to this approach is investing in assets that are uncorrelated, meaning they react differently to changes in the economy.

    Often, when interest rates are low, but the economy is growing, investors are encouraged to move into riskier sources of income and returns. For some, that means moving from bonds to stocks.

    The downside is that these investors could have a high exposure to equity risk in their portfolios. In this scenario, the investor’s portfolio is less diversified and potentially more vulnerable to an equity market sell-off (the event of rapid selling of stocks due to market movements or political events).

    Risk: Diversification and asset allocation may not fully protect you from market risk.

  • For a steady income stream, you have the option to invest in a mixture of bonds – some riskier, some less so. This provides diversification and can help to generate income without eroding your capital.

    The spectrum of bonds

    Income is a big reason why bonds have proven so popular with investors over the years. Both mutual funds and bond ETFs invest in a wide range of bonds, all of which seek to pay a fixed amount of interest.

    Many investors want to target a regular income without denting their overall returns. To achieve this income, diversification and an awareness of risk is key. Bonds deemed less creditworthy usually offer a higher yield. On the other hand, bonds perceive to be safer generally yield less. Investing in a diversified portfolio of bonds, right across the fixed income spectrum, can offer greater potential to achieve income goals.

    Risk: A main risk related to fixed income investing is credit risk. Credit risk refers to the possibility that the issuer of the bond will not be able to repay the principal and make interest payments.

  • Bonds are deemed less risky than stocks, because bondholders are repaid before shareholders if a company encounters financial problems. This makes them attractive to cautious investors who are seeking better returns than those available from cash.

    Are bonds deemed less risky than equities?

    Cautious investors who might not want to take a lot of risk with their capital often allocate part of their portfolios to fixed income. Unlike stocks, where the company does not promise to return your investment, bond issuers make a contractual promise to do so.

    In addition, if a company enters financial difficulty, bondholders are repaid before shareholders. Many investors find the capital preservation and portfolio stability offered by fixed income attractive.

    An alternative to cash

    Another option available to risk-averse investors is to keep their money in cash. When investing in cash, it’s important to remember the risk of opportunity cost – that the returns from cash are lower than the returns available elsewhere. An allocation to high-quality and/or inflation-protected fixed income assets can offer an effective strategy to limit portfolio losses, while leaving room for capital appreciation.

    Risk: The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

WHY iSHARES FOR FIXED INCOME?

Key

Access & breadth of range

iShares has the largest fixed income UCITS ETF range with over 90 funds offering access to virtually all parts of the fixed income markets.*

Diamond

Product quality

iShares offer tight tracking and the most liquid UCITS ETFs in Europe. Rigorous product construction and index selection ensure quality range.*

Person

Dedicated partner

Access to our global trading and implementation services, portfolio analytics and solutions and model portfolios.

* Source: BlackRock, Bloomberg as of 31 August 2020.

Risk: Two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to repay the principal and make interest payments. There is no guarantee that a positive investment outcome will be achieved.