A guide to fixed income

What is fixed income?

Fixed income refers to an asset class that is a form of debt and provides investors with a steady and predictable income stream. The returns on the asset are fixed giving the holder a clear picture of the payment schedule that will be in place throughout its life. A fixed income asset typically returns the face value amount at the end of its life. Fixed income assets are distinct from securities that provide a variable and uncertain return such as stocks and shares.

Is fixed income the same as a bond?

In the world of finance, the label fixed income is sometimes used interchangeably with that of bond, which can be confusing. Bonds are essentially the most well-known form of fixed income and have a long history of being used by governments and corporations to raise funds. There are a variety of other fixed income assets available to investors, but these are likely to be viewed less as straightforward bonds and more as speciality products. These can include products such as mortgage-backed securities (MBS) or asset-backed securities (ABS).

How do you generate income from a bond?

A standard bond issues a fixed payment known as a coupon at regular intervals, usually every six months. Bonds can rise and fall in value, giving the holder the potential to profit from the asset if the price goes up – a capital gain. It is also important to remember that when a bond comes to the end of its life, the holder receives the principal, or face value, back from the issuer.

How long does a bond last for?

The duration of bonds varies widely and investors can usually find securities to suit their preferences on this front. While the issuer is committed to paying the holder of a bond until the security matures, the holder can trade in and out of the asset quite easily. Just because a bond has a ten-year duration, it doesn’t mean the investor is obligated to hold it for the full period. On the flip side, some issuers like to offer what is known as a ‘callable bond’ which gives them the option to redeem the bond and pay any outstanding interest payments earlier than maturity.

What is the relationship of the bond price to the yield?

Yield is another way of saying return. If there is one thing anyone should try to understand about bonds, it is the relationship of price to yield. Whereas the coupon on a bond is fixed, the yield can vary, because yield is related to the price and the price is decided by the market. Once a bond is issued, its cost immediately becomes dictated by what the market is willing to pay for it. This variation means that when the price of the bond goes up, the yield goes down and when the price goes down, the yield goes up. The less you pay for the bond in the market, the more value you are getting from the fixed income stream it provides.

How risky are bonds?

Bonds are designed to be a predictable investment. They provide investors with a steady income stream and aim to return the face value of the security at the end of its life. However, there is always an entity, the issuer, behind a bond that is responsible for meeting the payment obligations. The risk levels of bonds can vary immensely. When you buy a bond, you are essentially placing a vote of confidence in the issuer to return your money to you along with some interest. Riskier bonds will sometimes be referred to as ‘junk’ or ‘high-yield’ while bonds deemed a safer bet are generally known as ‘investment grade’.

Are there independent organisations that attach a level of risk to bonds?

Credit rating agencies perform an important function in the bond markets by attaching a rating to issued securities. The best known of these rating agencies are Moody’s, Standard & Poor’s and Fitch. Rating agencies provide in-depth research on bonds and are often used as a useful reference point by investment managers such as W1M.

What’s the difference between bonds and equities?

There are some key differences between bonds and equities. Both are securities and can rise and fall in value, but bonds are a form of debt that provide a steady and predictable income stream before returning the principal value to the investor upon maturity. Equities represent an ownership share in a company and provide income to a holder in the form of dividends. Unlike bond coupons, dividends are a variable form of income and can even be stopped completely if a company deems it necessary.

Is it possible to invest in a basket of different bonds?

One of the simplest ways to invest in a basket of different bonds is through a bond fund. Bond funds give an investor access to a range of different bonds without the inconvenience of having to purchase them all on an individual basis. A bond fund means you can diversify your risk and not concentrate your fixed income investments too narrowly. There are a wide variety of bond funds on the market catering to all preferences. Whether you want to invest in the debt of European electricity providers or G20 governments, it’s likely there is a bond fund to suit your tastes. At W1M, we offer our own in-house bond funds to clients.