Christine St Anne: Many investors look to good dividend paying stocks to get income, but there are also income focused bond funds. To give us an idea about how these funds work, I'm joined by PIMCO'S Michael Dale.
Michael Dale: Thanks for having me, Christine.
St Anne: Michael, so what kind of assets are found in income-focused bond funds?
Dale: Well bond funds, especially income-oriented bond funds, really focus on two key principles; the preservation of capital, first and foremost, and then reliable sources of income, Christine.
So within an income-oriented fund, you really want to be looking for top quality sovereign or credit corporate bonds that is, that will pay you your face value at maturity, but also pay you a coupon that can be a real return, something when adjusted for inflation is very, very important in retirement and has very, very low default characteristics.
St Anne: How did these assets generate higher yield compared to, say, the more traditional fixed income funds?
Dale: Well, Christine, I mentioned before that one of the principle reasons of investing in a bond fund is to get reliable and timely income. So, we would say that a traditional fixed income fund or an income paying fixed interest fund really do have the same mandate when investing across securities.
If anything that would probably need to look at the type of credit quality associated with the fund that are investing in, and that will align with the kind of yield that they require on behalf of their client or for themselves.
St Anne: Michael, many investors are obviously invested in equities. Are these assets correlated to equities?
Dale: So what you need to think about there, Christine, is making sure you have a real diversified bond portfolio, whether it be global or Australian. Making sure you have a healthy mix of government securities, which are uncorrelated or the most uncorrelated asset to risk asset such as equities, and then also a healthy mix of strong quality corporate bonds that lie right up ahead in the capital structure and are very much uninfluenced by a fall out in the equity market or negligible fall out in the equity market. So that would mean that the default characteristics are very, very low within the income fund that you're paying will help mitigate it against any downturn in the equity market.
St Anne: So Michael, what are the risks investors need to be aware of?
Dale: When investing into a bond fund, Christine, really they need to be looking at the underlying credit quality of the bond fund. Really is there any default characteristics that can affect capital being returned to the investor at the maturity of the bond. Also the threat of timely income being eroded by inflation, but I would therefore say that active management becomes very crucial in this type of scenario, where active managers can make sure that they manage both the interest rate risk and the credit risk that I've just spoken about.
St Anne: Michael, you touched upon the bond rates, many investors have concerns about these rates, particularly the implications for yield, what is your view?
Dale: Well, we need to really think as an investor and what we're trying to get out and talk to people at the moment is, what a low bond yield is telling you about the economic environment around the world. It suggests that growth is going to be sluggish. It also suggests that central bank's policy rates are going to remain low for a long time to come.
Finally, it suggests that the consumer and the business are becoming very sluggish and very scared from a confidence point of view. So what you really need to make sure you have within your income-oriented fund or your bond fund for that matter is a very good quality portfolio that is uncorrelated to risk assets and that pays you timely income, whilst preserving your capital.
St Anne: Michael, thank you so much for your insights today.
Dale: Christine, thanks very much for having me. Appreciate it.