Fixed Income Online Course
Our fixed income online course is currently being rewritten. Below is a sample of the content. If you're interested in sitting the course please send us your details and we'll contact you when the course becomes available.
Fixed Income Online Course – Session 1 – Overview
Session description and content
At the end of this session you should be able to understand:
- the definition of the fixed income asset class
- why it is important for investors to include an element of fixed income in their portfolios
- the importance of capital structure when making decisions about investment classes
- the direct relationship between risk and reward – the greater the risk the greater the expected reward
What is fixed income?
Fixed income refers to debt securities (for example bonds) that pay a defined distribution (the coupon) for a given period of time (the term) and repay the face value of the security at maturity. A fixed income security or bond is a loan from an investor to the issuer of the security. Issuers of fixed income securities in Australia include the Commonwealth Government, state governments, banks and other corporations. The specific structure of a fixed income security can vary significantly depending on the issuer, term and maturity, coupon type and level of subordination.
Why invest in fixed income?
From an investor's perspective, the fixed income asset class covers a multitude of variables but the main purpose of the asset class is to provide a low risk reliable income stream and preserve capital.
Fixed income offers investors:
Capital stability
One of the key characteristics of most fixed income investments is the repayment of initial investments at maturity, or in some cases, over the life of the bond. Of course, capital repayment is subject to the ability of the issuer of the bond to meet this obligation. Fixed income includes a spectrum of issuers with different risks, however, all fixed income securities are guaranteed by their issuers so, assuming the government or the corporation or the issuer of the security remains solvent and does not go into liquidation, investor's receive repayment at maturity.
One of the lowest risk fixed income products is an Australian Government bond issued by the Commonwealth Government of Australia () which returns face value at maturity to an investor. Higher risk products like subordinated debt (bonds) and hybrid securities issued by a range of corporations including high and low risk entities offer much higher returns than government bonds. As long as investors are comfortable with the underlying credit quality of the issuer these assets can provide stability and diversity in a portfolio.
Regular income
Fixed income securities provide a regular income stream through coupon (interest) payments where the dates and amount of the coupon payable are defined at the time of issue. A portfolio of fixed income securities can be tailored to meet investor's cash flow requirements.
Diversification
Diversification spreads investment across a range of assets, maturities, industries and risks with the aim of reducing the impact of any one investment in a diverse portfolio. Fixed income allows diversification away from the two most highly cyclical asset classes – equities and property.
Fixed income products can counter-balance higher risk investments in a portfolio and they can serve to even out returns in times of high volatility. Most if not all balanced investment portfolios should contain a significant fixed income allocation to assure investors of their continued ability to meet ongoing business and personal commitments. The fixed income asset class offers a broad spectrum of products, risks, returns and maturities to provide a diversified and balanced portfolio solution for investors.
Ability to earn better returns than bank deposits
Many investors use term deposits which provide minimal risk but generally earn relatively low returns. One of many strategies investor's can employ is to invest in higher risk assets issued by the same institution which offer higher returns. By undertaking this strategy, the investor retains exposure to the same company (assured of its credit quality and ongoing viability) but improves overall return by taking a subordinated position within the overall capital structure of the issuer. See Figure 1 explaining capital structure below.
Ability to diversify the range of portfolio maturities
Bond maturities typically vary between one and ten years although bonds are tradable securities and can be traded before maturity. The investment return in this instance may differ from the initial yield.
Liquidity
Cash is an important component in a portfolio. Investors with cash can use it to pay their bills and maintain their positions. Equally, very low risk, highly liquid fixed income investments like government bonds can be sold at short notice if needed. Liquidity is a fundamental factor in building a portfolio. Assets that cannot be easily sold or traded in a secondary market need an appropriate return to compensate for illiquidity. An important function of liquidity is being able to sell an asset quickly without significant loss.
Protection against loss in a cyclical downturn
Generally, a fixed income allocation in your portfolio will act to protect it during a cyclical downturn. A greater allocation will provide greater protection. Setting your asset allocation and regularly rebalancing your portfolio, assuming a set fixed income allocation, should provide ongoing protection.
Capital Structure, Capital Structure, Capital Structure
Property investors know and respect the mantra location, location, location. Key in fixed income markets is where the product sits in the capital structure. So, if you decide not to complete the Focus on Fixed Income online course, take the fixed income mantra with you – capital structure, capital structure, capital structure.
Where an investment sits in the capital structure is crucial in determining whether the return adequately compensates the investor for the risk involved. Equities (or shares) are highest risk and should provide the greatest returns. In contrast most debt securities (with the exception of a very small number of hybrid securities) all sit higher in the structure and are safer in the event of liquidation. Generally they are lower risk and offer lower returns. Including debt securities in investment portfolios lowers volatility.
Risk has a direct relationship with reward. The higher the risk of a security the greater the expected reward. Investing a high proportion of your funds in the highest risk category, equities (shares) can expose your portfolio to loss in a cyclical downturn. Fixed income securities which are lower risk as they sit higher in the capital structure generally lower the risk of your overall portfolio, helping to preserve capital. See Figure 2 below and see Session 3 for more information.
