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...

Bogle forecasts low stock and bond market returns
21/10/2016  Warning of "much lower market returns" ahead, Vanguard founder Jack Bogle urges investors to seek low-cost investment products. From Morningstar US.
Finding the right flavour ETF amid expanding ETP menu
13/10/2016  From a relatively vanilla selection of exchange-traded funds (ETFs) on offer in the early 2000s, Australian investors can now choose from a wide range of exchange-traded products to suit various tastes.
Bright outlook for Aussie banks despite parliamentary committee and looming Basel IV regulations
12/10/2016  Australia’s ‘big four’ banks’ share prices have held up after their CEOs last week fronted a parliamentary committee, and have already absorbed the potential impact of more stringent capital requirements
Dividend, cashflow challenges hit investors but yield opportunities remain
06/10/2016  Technology, healthcare and telecoms hold opportunities for global equity investors even as utilities and energy stocks disappoint, says Jane Shoemake, director for global equity, Henderson
No place for set-and-forget asset allocation
04/10/2016  A 2016 company reporting season overview and explanation of why dynamic asset allocation is so important, from Dr Shane Oliver, chief economist and director of investment strategy, AMP Capital.
The search for bond yields
27/09/2016  Morningstar's Hybrid Handbook: Navigating the Australian Hybrid Market pulls back the curtain on corporate and bank hybrids, as John Likos, Morningstar's senior credit analyst, explains.
Here's which stocks will be the real winners in FY17
15/09/2016  Morningstar's Peter Warnes reflects upon the most recent corporate earnings season and shares his thoughts on which stocks could deliver strong performances in the near term.
Resolution Capital Global Property Securities
13/09/2016  Morningstar's Ross Macmillan examines a number of outstanding qualities that sets Resolution Capital apart from other managers.
India: Economy slows but stock market outlook is bright
07/09/2016  Despite poor recent performance, India remains a key investment for emerging market investors. Fidelity's Medha Samant explains the position.
China rally will continue but prepare for volatility
07/09/2016  Last year, volatility in the Chinese stock market spilled over into global stocks. This year, the market has been more encouraging--will the rally last?
Helping SMSF trustees negotiate super complexities
19/08/2016  Peter Hogan, head of technical at the SMSF Association, shares his insights on the changing super environment and how it will affect SMSF trustees.
Chasing income in a low return world
10/08/2016  Paul Reisz, Pimco's executive vice president and income product manager head, gives his insights on where bond investors may find yield in the difficult global market environment.
US stocks offer most attractive income, says Investec
03/08/2016  Investec's UK-based global equity income investor Blake Hutchins says despite the stock-market rally raising valuations, the US offers the most attractive options for income investors.
US stocks which will continue to rally
28/07/2016  The US stock market looks fairly valued as a whole, admits JP Morgan's Dennis Ruhl--but there are some sectors which will deliver further growth.
Xero underlines returning popularity of technology stocks
19/07/2016  The success of accounting software company Xero is part of a broader resurgence of technology companies, contrasting with the shifting fortunes of Australia's resources sector.
Zurich Investments Global Thematic
18/07/2016  Morningstar's Kathryn Young explains what sets Zurich Investments Global Thematic apart from rival global equities strategies.
Gold Managers: Platinum International Fund
15/07/2016  Morningstar's Kathryn Young explains what makes Platinum International a standout strategy and the rationale behind the fund's Gold rating.
Gold Managers: Magellan Global Fund
15/07/2016  Morningstar's Tim Wong explains why the Magellan Global Equities was upgraded to Gold and why there is more to the strategy than Hamish Douglass.
Is this graph to blame for Brexit?
13/07/2016  Britain's vote to leave the European Union seems to tie in with a feeling across the Western world--a rebellion against globalisation and those in power.
Global equities versus Aussie equities
11/07/2016  While global equities may be attractive on a relative valuation basis, it's important not to blindly follow a benchmark, Morningstar Investment Management's Brad Bugg says.