Why invest in Fixed Income?

Fixed income investments offers various benefits, depending on investor needs:

Diversification:

For investors who are exposed to a wide range of risky assets, the defensive nature of fixed income through diversification is most crucial.

Traditional fixed income is negatively correlated with other asset classes such as equities and is also typically less volatile. However, it should not just be thought of as a substitute for cash as bonds have duration that typically rise in value when equities fall.

Therefore, a balanced portfolio with a reasonable fixed income allocation should perform well under a variety of economic scenarios and ultimately reduce volatility of returns.

Capital preservation:

While shorter-duration products are usually held for capital preservation, longer-duration bonds held to maturity (which does not default) will also return all of its initial capital.

Although a fixed interest portfolio may not always hold bonds to maturity (often in order to capitalise on fluctuations in bond valuations through active management), the portfolios themselves will still benefit in the long run from this defensive dynamic - a security sold at a loss will typically be used to purchase a cheaper one.

Regular income stream:

As the name suggests, investing in fixed income offers income. Many investors, particularly retirees, benefit from a regular income stream.

Additional credit risk may give yield enhancement, which is more consistent and, on average, higher than interest earned on cash and term deposits.

Different objectives of fixed income

Why do bonds go up in price if yields go down?

Or, for that matter, why do bonds go down in value when yields go up?

There is an inverse relationship between bond prices and movements in yield. If interest rates go up, the price has to fall in order for the yield to remain competitive, and vice versa.

Existing investors who have locked in yields look for prices to rise; new investors look for prices to fall in order to capture a higher yield.

This can be confusing as sometimes investors think that a bond pays interest and thus will benefit from rising interest rates. This is incorrect as the interest earned by holding a bond is instead always fixed, as set by the coupon rate.