Navigating the fixed-income maze
Christine St Anne  |  24/01/2013Text size  Decrease  Increase  |  

Christine St. Anne: When it comes to the fixed income asset class, investors are faced with a plethora of choice. To navigate the choice on offer and what fixed income means to your portfolio; I am joined by Morningstar's Kathryn Young. Kathryn, welcome.

Kathryn Young: Thanks so much for having me, Christine.

St. Anne: Kathryn, what are the main categories in fixed-income?

Young: It's a good question, Christine, actually because many people think that fixed-interest; it's all the same. It's just one big asset class, not a lot of difference there, and there actually are quite a few different sectors within fixed interest.

At Morningstar, we have six different categories that we cover in fixed-interest, but you can really talk about them in three main categories.

So, one is domestic bond, so that covers Australian Commonwealth bonds, the state government bonds, and in some credit, a lot of bank's incorporate bonds. But then there is also global bonds which cover governments from around the world – investment-grade countries around the world issued by governments. There is also some credit involved in global bonds. And then the third sector is just credit itself. And so, by credit I mean bonds that are issued by corporations. And credit bonds typically tend to have a bit higher yield than government bonds, because there are some credit risks related there. So, for example, credit risk is the risk that the corporation goes bust and doesn't repay you your money.

St. Anne: In an environment of falling interest rates, Kathryn, what role do these assets play in a portfolio?

Young: Fixed-income assets always play the same role. They also play a defensive role typically; income-generation role, and they provide diversification to balance out the equity part, the share parts of an investor's portfolio, but that role becomes especially pertinent and visible when interest rates are falling. Typically, when interest rates are falling, it's associated with economic weakness and often risk aversion among most investors.

So, when there is economic weakness and investor risk aversion, shares are typically falling, and in that case when interest rates are falling, bond prices go up. And so, what happens is the bond part of your portfolio is doing well at the time when your equity part of your portfolio isn't doing as well. So, you can see that it really – it helps balance out and cushion some of those losses.

St. Anne: With the hunt for yield, can these assets boost the income of an investor's portfolio?

Young: A lot of people are really talking about this because with yields on government bonds; really all bonds, the yields are at or near historic close, and so that means that they're not generating as a much income as people had gotten used to. So, a lot of investors are turning to credit-sensitive bonds issued by corporations for the most part at a time like this, because as I mentioned before the yield on those bonds tends to be higher to compensate investors for the credit risks.

So, many professional investors and many retail investors are looking to credit at a time like this, especially because many corporations globally are in good shape or have been in good shape since the global financial crisis, so there people feel more comfortable taking on that credit risk.

I think it's important to point out though that if investors are looking to corporate bonds to credit sensitive securities that it's -- I would advise most to consider using a mutual fund or unit trust, so that there is a professional manager and professional researchers looking at the credit risk involving those bonds, because it can be quite complicated for a person who has another job to do.

St. Anne: Finally, Kathryn, how could investors access these strategies?

Young: First and foremost, you need to decide what kind of strategy is appropriate for you. So, we talked about domestic bonds, global bonds and credit sensitive bonds. So, we always recommend that people stay well diversified. And so one simple way to do that might be to look at, Morningstar has a category called global Australia bonds and what that is, is just one fund that offers exposure to global bonds, to domestic bonds, and often will have some credit exposure as well. So, one of those strategies might be an easy place to start, because then you have a manager who is allocating across those different sectors and keeping you well diversified.

The second thing that you want to do is make sure that the security that you're looking at has a risk profile that matches what you intend to do with that money. So, for example, if you're just looking to invest money that you might need to use in the next two years, say to buy house or to fund your lifestyle, then you want to make sure that it's a very low, low risk type of security. So, in that case you might look at for at term deposit, but you might also look at a very short-term fund. And we have a category for that as well it's just called Australia short-term fixed interest. So, with that that risk profile would match up with what your goal is.

Another way to look at risk portfolio of a more diversified fund would be to look at the fund's performance since 2008. If it has a lot of credit risk, that fund probably lost money in 2008, because a lot of corporate bonds struggled during the global financial crisis the worst of it. So, that might help to give you a sense of how much credit risk is really in that fund. But you could also look to some other statistics, such as its credit quality breakdown. A lot of funds, funds that have a lot of their assets invested in non-investment grade bonds that might be -- that would indicate that it's a higher credit risk profile.

And then lastly, you want to make sure that the manager - if you choose a fund, you want to make sure that the manager has the resources to be able to do the right research effectively and you can tell that in many ways. A very simple thing to do would just look at how long the track record of the fund is. It might help to give you a little bit more confidence if the fund has a very long track record; investors have been investing with this firm for a long time. You also want to take a good look at fees. Fees are especially important within fixed interest, because the range of returns offered by fixed interest is lower. So, that means that fees necessarily take a bigger bite out of the income and the returns that the investor gets. So, you want to pay a special attention to fees.

St. Anne: Kathryn, thank you so much for your time today.

Young: Absolutely, happy to help.

Video Archive...

to Morningstar Premium Membership

Quality stocks, sustainable yields
26/11/2014  Anton Tagliaferro of Investors Mutual shares his outlook for the market at last month's Morningstar Individual Investor Conference.
Key risks in bond investing
21/11/2014  There are a number of risks investors need to consider in bond investing.
Confronting volatility and low growth
18/11/2014  Given issues such as recent volatility, rising global debt levels and the threat of European deflation, there are steps investors can take to safeguard their portfolios.
Medibank: A quality business at the right price?
13/11/2014  The health insurer is a quality business but it will all come down two the price, according to two fund managers.
Telstra and sustainable returns
12/11/2014  The Australian telecoms giant has some exciting growth opportunities ahead of it and will continue to provide sustainable returns over the longer term.
Bank earnings wrap-up
07/11/2014  Morningstar sector head of financials David Ellis gives investors the lowdown on the most recent batch of earnings from Australia's major banks.
Medibank IPO Report
29/10/2014  While there were a few "surprises" in the prospectus, health insurer Medibank Private is still on track to deliver growth, according to Morningstar's Peter Warnes and David Ellis.
Opportunities in fixed income
28/10/2014   Bentham Asset Management principal and portfolio manager Richard Quin provides investors with some insights into fixed-income investment and the role that short-duration credit can play in a portfolio.
Key investor risks
21/10/2014  Voted among the 50 most influential people in finance today, author and former banker Satyajit
Finding value in small companies
14/10/2014  A portfolio of "terrific value" can still be achieved despite the stretched valuations in the smaller end of the Australian equities market.
Choosing quality businesses
07/10/2014  Credit investors adopt a different approach to equity investors when assessing a quality business, according to PIMCO's Tracy Chin.
Don't panic about PIMCO
30/09/2014  Morningstar's Tim Murphy talks about the recent portfolio manager changes at the global bond manager and why investors should not panic.
Medibank IPO Preview
25/09/2014  Morningstar's Peter Warnes and David Ellis preview the upcoming initial public offering of health insurance giant Medibank Private.
A better deal for investors
24/09/2014  Morningstar’s Anthony Serhan outlines what the government’s Financial System Inquiry will mean for investors.
Europe growth: Gone for good?
18/09/2014  Facing entrenched structural issues, the eurozone’s days of robust growth are likely over, but there are some reasons for hope, says Morningstar's Bob Johnson.
Morningstar Individual Investor Conference
09/09/2014  Whether you are building your savings or transitioning to retirement Morningstar will help you secure long-term returns. This conference is not to be missed. Register now.
Will the ECB cuts boost growth in Europe?
09/09/2014  The European Central Bank (ECB) has taken measures to ward off deflation and boost growth in the eurozone. Will these interest rate cuts be effective?
Building a moat in foreign exchange
03/09/2014  OzForex’s low-cost, online business model could prove to be a meaningful market disruptor, and the shares look like a bargain today.
1 stock that's close to perfection
29/08/2014  Morningstar head of equities research Peter Warnes discusses results from the likes of Ramsay Health Care and Woolworths as the curtains close over the fiscal 2014 earnings season.
Why moats matter
26/08/2014  Morningstar Australasia's co-chief executive Heather Brilliant talks about finding great companies in a new book she co-authored titled Why Moats Matter.