A beginner's guide to investing in fixed income

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We demystify fixed income investments and explain how to invest (and why you probably should).

Most Australians understand how shares and property work, but fixed income tends to be more of a grey area.

Yet fixed income has a lot to offer a portfolio.

sponsored a beginners guide to fixed income

With the right strategy, fixed income can deliver the sought-after trifecta of high yields, regular income and capital stability.

To see how, let's take a closer look at what's involved.

How fixed income works

Anyone with a home loan or personal loan understands how debt works.

Fixed income investments let you put the boot on the other foot, allowing you to become the lender so that someone pays you interest for a change.

Whether you put your money in a term deposit or government or corporate bonds, you are basically lending money to another party - the bank, the government or a large company. As with any loan, you can expect to be paid interest in return for the use of your money, and at the end of the term your capital is returned to you.

In this way, fixed income can offer attractive yields, a regular flow of income and the potential for capital stability.

These are strong points of appeal, which explains why your super fund is likely to invest in fixed income.

In fact, the global bond market is almost three times the size of global share markets.

How to invest in fixed income

The catch is that fixed income investments can require large sums of capital.

Government and corporate bonds, for example, often have a minimum investment of $500,000. This makes it difficult for retail investors to directly access this asset class.

The solution is to invest in a fixed income fund.

There are exchange traded funds (ETFs) that focus on fixed income. The downside is that ETFs are traded on the share market, and so can experience similar levels of volatility as equities especially during a market rout.

By contrast, unlisted fixed income funds have very low levels of volatility as well as providing much-needed portfolio diversity.

In addition, an unlisted fund manager like Mutual Limited is able to use their team's skill and experience to identify opportunities for high yields while minimising risks.

This approach involves plenty of analysis, comparing bonds for value, and conducting extensive research on the bond issuer to determine their financial health and overall strength.

However, the result can be significant outperformance.

Over the past 12 months alone, the Mutual High Yield Fund has outperformed the Bloomberg AusBond Bank Bill Index by an impressive 7.0%. Most ETFs, on the other hand, only aim to match a particular benchmark.

Performance of fixed income assets

Of course, the big question for investors is the sort of returns they can expect to earn with fixed income.  As always, returns are linked to risk.

By way of example, the Mutual Cash Fund, which holds a basket of the best term deposits across the major banks, has generated returns of 4.52% over the past year.

Term deposits are a very low risk investment, and so is the Mutual Cash Fund. One of the chief benefits of this fund is that investors' money is not tied up for lengthy periods as it is with a directly held term deposit. Investors only need to provide two days' notice to access their money.

From here each Mutual Fund has a higher level of risk, which is reflected in higher returns.

At the higher end of the risk spectrum, the Mutual High Yield Fund, which invests in a portfolio of residential mortgage-backed securities, has delivered returns of 11.24% over the year to 30 April 2024.

What to watch for

One factor to watch for with fixed income securities is 'floating' (variable) versus 'fixed' rates.

The price of a fixed rate security typically falls if market interest rates rise because the fixed return becomes less attractive.

On the other hand, the price of floating rate securities remains the same regardless of rate movements, and all other things being equal.

This is why Mutual Limited only invests in floating rate securities.

Yes, it means yields can change. But investors' capital remains stable. That's great news for investors concerned about volatility, or for those looking to preserve the value of their capital.

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Scott Rundell is the chief investment officer of Mutual Limited. He has more than 25 years of financial markets experience, specialising in fixed income investment strategy, portfolio management, fundamental credit analysis, and relative value analysis in both the high yield and investment grade space. Scott holds a Bachelor of Economics from La Trobe University and a Masters of Finance from RMIT.