Investment Professionals

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Why Invest in US Fixed Income?

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What is fixed income?

Fixed income securities come in different types, the most common of which are bonds. Bonds are debts issued by governments and companies. But unlike bespoke loans, bonds are built in structures that are somewhat standardised so they can be easily traded.

Investors often use fixed income, especially bonds, in their portfolios. This is because bonds are safer than other kinds of assets, such as property and shares. The reason they are safer owes to the legal protections that bond holders enjoy. Bond holders get priority over shareholders when it comes to cash flows. That is, companies are legally required to pay interest to bond holders before they can conduct buybacks or pay dividends, which reward shareholders. Companies that fail to meet obligations to bond holders are forced to default.

Bond repayments are also non-discretionary. Unlike dividends, companies are legally required to pay coupons and principal on certain dates.

What are the benefits of investing in fixed income?

Depending on your financial goals, fixed income, including bonds, can offer a variety of benefits.

Capital stability

Protection of capital, while providing a potential return, is the primary benefit of fixed income. Fixed income securities are less volatile than other assets such as shares and commodities, this owes to the greater legal contingencies protecting bondholders. This means that fixed income investments can be useful to investors with lower risk appetites.

Income

Fixed income securities pay reliable income. The size of income payments will depend on the risks investors take. Generally speaking, more risk creates more income. For example, buying the bonds of riskier companies – sometimes called sub-investment grade – can come with higher yields. So too can buying bonds with maturity dates in the very distant future. Higher income usually owes to higher risk, meaning bond investing involves a balance between risk appetite and hunger for yield.

Diversification

Fixed income securities can be used to diversify portfolios. As fixed income securities are usually less volatile than shares, they are often used to provide ballast in portfolios and limit drawdowns.

What are the risks of investing in fixed income?

While less risky than investing in shares, fixed income investing comes with risks nonetheless. There are three major risks.

Rising interest rates

When interest rates rise, bond values typically fall. The degree to which rising interest rates cause a bonds value to fall is measured through “duration”. As such, monetary policy and central bank decisions – or even market expectations of monetary policy or central bank decisions – impact bond values.

Default

Bond holders suffer losses when companies or governments fail to repay. This risk is usually called credit risk, and is typically measured by credit ratings agencies, such as S&P, Moody’s, Fitch. More creditworthy borrowers receive investment grade ratings and usually borrow money at lower interest rates.

Inflation

Inflation erodes the real value of bonds. As bonds provide fixed payments over specified dates, if the size of bond coupon payments is outpaced by inflation investors can suffer losses. For this reason, bonds are best thought of as a hedge against deflation, not inflation.

What is US fixed income?

Bond markets are common around the world. Australia, like most other countries, has one. Companies – and governments – looking to raise money can shop between jurisdictions when raising capital. For example, foreign companies often borrow money in Australia. (When foreign companies raise Aussie dollar bonds, their bonds are called “Kangaroo bonds”).

The US Treasuries Market is Deep and Liquid

The_US_Treasuries_Market_is_Deep_and_Liquid_US_6f31b8202f.pngSource: SIFMA. Data sourced on 29 June 2022.

While global, the largest bond market by a substantial margin is in the US. Companies – including Australian companies – will tap the US capital market to raise money. For borrowers, the primary advantages of raising money in the US are that the US dollar is the world’s reserve currency. And the fact that the US bond market is supported by the largest banking ecosystem, providing easier access to credit.