Fixed Income – Why include bonds in a portfolio
Many investors seek growth in their portfolios and generally hold a component of risk assets, whether equity, property, infrastructure or other exposure, especially if they are investing for the longer term.
However, these assets are known as ‘risk assets’ for a reason – investors may face uncomfortable losses from time to time. To overcome the short-term discomfort of large unmitigated losses, many investors who wish to stay invested for the long term often make an allocation to fixed income, in an effort to navigate through challenging market environments.
As with any asset class, fixed-income investing has its benefits and risks , but there are several reasons to consider devoting part of a portfolio to bonds:
1. Relative capital stability
Historically, bonds have provided greater valuation stability than stocks, commodities, foreign exchange, and other asset classes. Even when bond markets are volatile, fixed income is still regarded as a valuable buffer against uncertainty.
2. Regular income
Although some bonds offer no coupon payments , most bond investments provide investors with a regular income stream. This can appeal to anyone needing to manage cash flows to meet regular expenses, such as those in retirement.
3. Diversification
Investors may benefit from having at least some level of diversification in their portfolios. In essence, diversification refers to the fact that various types of financial assets behave differently in response to market conditions at any specific time.
Generally speaking, stocks tend to fluctuate between rallies during bull markets and sometimes substantial falls in bear markets. During risk sell-offs, high quality government bonds have often kept their value or have even gone up in value as investors seek what they view as safe-haven assets.
So, by holding both stocks and government bonds in your portfolio – in a proportion that matches your risk appetite – your investments may be better balanced than if you were concentrated in one or the other. When stocks are underperforming, bonds might be outperforming, and vice versa. However, this is only one example of the application of bonds in a broader portfolio because the fixed income universe is so broad and diverse that investors can select from a range of exposures to match different investment goals, risk appetite, or desired return profile.
Something for everyone
It is possible to fine-tune your investment strategy by incorporating exposures from a broad selection of fixed income instruments:
Government Bonds: |
Often, the foundation of a defensive investment strategy is highly rated government bonds, which can offer relative stability at a typically modest interest rate. |
| Corporate Bonds: | Corporate bonds typically provide a higher yield than their government counterparts (of a similar maturity). Similar to government bonds, these may also vary in terms of risk and return profiles, from investment grade to high yield. |
| Mortgage-Backed Securities (MBS): | MBS pool together mortgages that have been originated by the lender. Shares of the MBS are then sold to investors who receive any cash flow generated by the underlying mortgages. MBS offer potentially attractive yields compared to government bonds and can provide a source of regular income. |
| Emerging Market Debt (EMD): | EMD refers to the bonds issued by the governments of (or companies operating in) developing economies. The appeal of EMD lies in the growth potential of emerging markets and the prospect of higher yields, reflecting the elevated risk level involved in such investments. |
| Private Credit: | Private loans (also known as “direct lending”) don’t involve banks or public markets. They are an increasingly popular addition to fixed income portfolios, frequently offering higher income than public credits due to their reduced liquidity. Many investors also consider private markets to add diversification to their portfolios. |