4 keys to fixed-income investing

Nicholas Grove  |   16/06/2015 Text size  Decrease  Increase   |  
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Nicholas Grove: I am Nick Grove at the Morningstar SMSF Conference in 2015 and I am joined by Morningstar's John Likos. John, what are the main risks investors should be cognizant of when it comes to investing in fixed income?

John Likos: Nick I think the most significant risks that investors should focus on are credit risk in particular, the risk that the principal and the coupon payments won't be made -- that's the main driver in our risk assessment. However, there are several others and we think liquidity is a key risk as well. So, analyze the liquidity of the bond that you're holding, look at the issue size, look at how it's traded recently. How easily can you get out of that if you need to at some stage? And we also look at risks such as concentration risk, where we want to ensure that clients are well diversified across their bond holdings -- those are probably three of the key ones that are out there Nick. I mean there are others, but they are the three key ones that we'd focus on.

Grove: John, in your presentation you spoke about the four C's of fixed-income investing. Can you just briefly talk us through those?

Likos: Of course, I suggested the four C approach because it's a very easy to follow, very easy to use approach and I think it's accessible to anybody really. So, it's a well-known framework in credit circles as a bit of a test. We like to look at let's say the character of the company that's issuing the bond. We like to look at the capacity of that company to make payments as due again on their principal, on their coupon payments. We like to look at the collateral -- is there any collateral, backing those bonds, those securities? And we like to look at the covenants. Have a look at the terms of the bond that you're buying and see if there are covenants, any restrictions on the company. What they can do. What they can't do in times of the need or distress. I'd say it's a very good framework to kick it off with.

Grove: Just finally John, what sort of hybrid issues have caught your eyes so far in 2015?

Likos: Look, we've had some banks come to market this year. We've had NAB come to market, we've had ANZ come market. Issue sizes haven't been as big as what they were at let's say at the CBA PERLS VII level. We've seen both of those NAB and ANZ issues come into approximately $1 billion each, give or take. But they've been received pretty well by the market. The pricing has widened since last year, so the market is adjusting it's perception of risk on these securities, which is good. But we've also seen a little bit of institutional buying this year. What we might be seeing I think evolving is issuers maybe trying to target institutions as well with smaller-sized issues, but that still needs to play out. But it's definitely something we're watching.

Grove: John, thanks for your time today and happy birthday for yesterday!

Likos: Thank you very much.

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