Fixed income: What is it, and why invest in it now?
Fixed income investments can be a means of preserving capital and achieving a predictable return. Bond investments can offer consistent income streams in the form of interest payments. This appeals to investors especially in choppy economic waters. What is fixed income, and how should it be deployed in a sound investment strategy?
What is fixed income?
Fixed income refers to bonds with fixed, regular interest that is paid out over a specified period. Companies and governments use them to borrow money on the capital market for a specific term. In this case, the investors are lending money to the issuer and receiving interest on it. They then receive their capital back at the end of the specified term. Fixed income refers to securities with a fixed interest rate. You may have also heard the terms "fixed-interest securities" or "fixed rate bonds."
What types of fixed-interest securities are there?
Fixed income includes bonds such as government bonds and corporate bonds. These securities include high-yield bonds that do offer the opportunity to generate high returns, but also carry an equally high level of risk. Convertible bonds are also corporate bonds. However, these can be exchanged for a set number of shares in the issuing company. This means that their value depends on a fixed income component as well as an equity component.
Other options for securities that pay out fixed interest rates include debt securities, mortgage bonds, and funds such as fixed income ETF. These can all be part of a fixed income strategy.
What are the risks of fixed income?
The advantage of fixed rate bonds or fixed-interest securities is that they help to diversify an investment portfolio. However, investors must also be mindful of the following risks.
Interest rate risk
The interest rate risk means that a bond can lose value due to changes in interest rates. The rule is: When the market interest rate falls, the bond price rises. If the market interest rate rises, then the price of the bond falls.
This is the risk that an issuer, such as a company, will not be able to repay the bond. In the worst case scenario, investors can lose all of the capital invested. Note: The lower the credit rating – or, in other words, the creditworthiness of the issuer – the higher the risk. Creditworthiness is assessed by international rating agencies.
If the purchasing power of the money falls due to higher inflation and the interest payments on the bond are unable to offset this deficit, the buyer will incur a loss. This is inflation risk.
There is a risk that investors will not find a market for the bond, which may prevent them from buying or selling when they want.
Fixed income strategy – what matters for investments
In 2022, Credit Suisse experts identified a positive correlation between bonds and equities, rendering diversification gains unrealistic. This strong correlation was due primarily to high and volatile rates of inflation, which pushed interest rates up while driving bond and equity prices down. As inflation declines this year, bonds are likely to regain their diversification benefits for the portfolio.
Even within fixed-interest securities, the ideal portfolio is diversified, for example, with a mix of government bonds, corporate bonds, and high-yield bonds. This could help to minimize risks while increasing the chances of stable returns. One option is to choose an actively managed fund with fixed-interest securities that offers a good balance between risk and income.
Fixed-interest securities: Long-term investment strategies are preferable
Which strategy for investments or securities is better? Investors in fixed income achieve the best results in the long term. Next comes staggered investments. The current high levels of return indicate the possibility of generating higher expected returns for fixed income segments in the future. The combination of “time on the market” and strategic asset allocation could prove to be the ideal formula.
Fixed income in 2023*
In 2022, the bond market showed the strongest correction in decades. Record inflation and rapid interest rate hikes left financial markets unsettled, drove bond yields to historically high levels, and put a major damper on prices.
In 2023, fixed-interest securities are likely to recoup some of their losses from 2022: The US Federal Reserve (Fed) is expected to reach its highest interest rate in March, while the European Central Bank (ECB) is expected to reach its highest interest rate of 3.5% in Q2. As a result, global key interest rates are likely to peak in Q2. The fact that overall inflation has slowed in the US since the summer of 2022 and in the eurozone since last October will likely also be beneficial to bonds.
One thing is clear: Fixed income markets have become more appealing than other asset classes. According to Credit Suisse, investors with a low percentage of fixed-interest securities in their portfolio should consider increasing their core fixed income allocation. For example, corporate investment grade bonds are likely to be interesting if central banks announce a slower pace of interest rate hikes. Due to the current interest rate differences and the varied outlook for further interest rate increases, US Treasury bonds are also likely to have higher yield potential than eurozone sovereign bonds. Bonds in hard currency from emerging markets may also provide attractive earnings prospects in 2023.
*To the extent that these materials contain statements about the future, such statements are forward looking and are subject to a number of risks and uncertainties and are not a guarantee of future results/performance.