What You Need to Know About Fixed Income Investments

Reviewed: July 22, 2015
By FinanceWeb

Fixed income investments have had only modest second quarter gains, but a big volume year continues. On a year-to-year basis, the volume has grown as business and government borrowers continue to take advantage of low-interest rates. The increase may also be due to plans to raise rates and thereby increase the costs of borrowing. The total of corporate borrowing both highly rated and junk bond issuers is at $934.2 billion which is a substantial increase from $864.6 billion last year.

News and Events Play Key Roles

News and events influence investor behavior and outlook. The Greek default and bailout caused many investors to pause and wait for signs of a long-term resolution. The Greek debt crisis had a potential to upset markets across the globe. Another market impact situation occurred in China where a severe correction required government intervention. In the US, the expected Fed Reserve action to raise interest rates has reduced the market for bonds as investors wait to see if rising interest rates may lower the value of bonds.

International Bonds and the Euro

The Greek debt crisis is potentially important to every investor, but its implication may be more direct for holders of international bonds. Government-issued foreign bonds may be nominated in Euros and influenced by the value of the Euro relative to the dollar and other reserve currencies. In the US, the direct stake in Greece is relatively small; most major investors sold off their Greek assets after the crisis erupted in 2010. Some investors were lured back by hopes of a revival of the Greek economy; those investors may be most concerned with the current bailout and further negotiations.

Volume is Up

High yield fixed income bonds showed the larger rate of return more than investment grade bonds. The secondary market for high-yield bonds responds sharply to events and interest rate increases with yields and prices heading in opposite directions. The volume of high-yield issues has stayed close to last year’s total at approximately $190 billion. The investment grade issues have increased sharply from the past to current year; it has risen from $367 billion to $460 billion. The increase in volume pushes prices down.

Second Quarter and Midyear Totals

In the second quarter, the impact of supply, news, and events held investment grade securities to a negative 2.5 percent. Treasuries joined the downside posting a 1.7 percent loss. US junk bonds issuers showed a small gain of one-tenth percent. For the year, the mid-year totals show high-yield bonds leading the way in fixed income securities with a gain of 2.5 percent. Investment grade bonds lost four-tenths percent, and Treasury notes lost one-tenth percent. The option adjusted spread is above 500 basis points over Treasury notes. This is the largest spread of bonds over Treasury notes in nearly six months.

Balancing a Portfolio

Fixed income bonds can help balance a portfolio in a rising interest rate environment. A segment of a well-balanced portfolio should include an exposure to fixed-income securities. A typical allocation might be 70 percent invested in investment-grade bonds, 20 percent in high yield bonds, and ten percent in international bonds. Given the current market, many investors prefer a greater proportion of high-yield bonds. Bond values can fall as interest rates rise, and while experts agree US rates will rise, many feel that the increases will be small and implemented slowly.

Improving Fixed Income in the Current Market

When developing strategies to generate fixed income, many investors start with adjusting the overall portfolio. Fixed income investments have a place in a diversified mix designed to survive the effects of market volatility. International government and corporate issues may pose a greater risk of wide fluctuation than US bonds due to the impact of the Greece bailout on the value of the Euro.

Taking a Middle Road Strategy

Shortening maturities is a standard defense for holders of fixed income securities against sharply rising interest rates. The current scenario suggests interest rates will rise above near zero but gradually and slowly. High-yield bonds can protect income against low-interest rates. High-yield securities have performed better than investment grade bonds, but they have not generated large year-to-date gains. One strategy is to straddle the fence on rising rates and protect against slow or no rate increases. With two potential interest rate outcomes, intermediate term bonds are a good way to improve income from fixed income securities. Good choices for intermediate term securities include tax-free municipal bonds, intermediate mutual bond funds, and mutual funds that invest in variable interest rate securities.