Building an effective fixed income portfolio
Fixed income plays various roles within a SMSF, depending on the investor’s risk profile. But its main purpose is to provide a consistent income stream, and to help balance out the returns from the fund’s growth assets.
A fixed income allocation within a growth portfolio acts primarily as a defensive asset, dampening volatility and offsetting weakness in equity markets. An allocation within a conservative portfolio, however, is intended to generate income and help preserve capital. Fixed income investments within both growth and conservative portfolios can boost liquidity and capital stability.
Making an allocation
There are many different types of fixed interest assets including sovereign debt, the spectrum of debt structures issued by corporations and other entities and even term deposits. The breadth of the asset class means choosing the right fixed income instruments can be a challenge for investors.
The Australian retail market offers fixed income investments including:
- Traditional Australian bonds
- Global bonds
- Investment-grade corporate bond funds
- Diversified credit funds
- High-yield funds
- Unconstrained bond funds
- Absolute return bond funds
Investing in corporate bonds – investment-grade, rated corporate bonds in the Australian market, and also in global bond markets, from companies in stable industries – is generally safer than investing in equities from the same company. Bonds are higher up the capital structure than shares, so if a business enters administration, bondholders will be repaid before equity holders. They also provide higher expected returns than cash, term deposits and government bonds.
How do I build an effective fixed income portfolio?
The first consideration when building fixed income into a portfolio is the investor’s investment objectives. The idea is to choose investments that will help to meet these objectives, also taking into account the investor’s risk profile.
There is a number of different objectives SMSF investors can aim for when building their fixed income exposures. These include:
- Diversifying the risk attributes of the fixed income exposure to include instruments with different durations and credit qualities.
- Providing a consistent income stream by allocating funds to fixed interest sub-sectors such as corporate bonds and securitisation.
- Gaining exposure to global income assets.
- Helping to preserve the fund’s existing capital.
- Ensuring the portfolio is structured to match their risk profile.
There are lots of different considerations to make when selecting a fixed income investment. First, ensure the instrument helps meet the SMSF’s objectives and that it is also in line with your risk profile. Ensure you fully understand the risk involved if you are investing in riskier fixed income investments. For instance, if you are investing globally, make sure you understand the country-specific risks involved and, importantly, ensure the potential reward justifies the risk of investing offshore.
If you’re investing in a fixed interest fund, have a look at its draw-down profile and assess whether it has delivered the returns you would expect from a fixed income investment over time.
Fixed interest is an important part of many SMSF funds. But there is a range of different options to choose from when you allocate to this asset class and it pays to thoroughly research the sector before taking a decision to invest.
About the author
David Carruthers, Head of Credit and Core.
David leads the credit and core portfolio management team, and is responsible for macro credit research, portfolio strategy and risk. He contributes to the macro (rates and foreign exchange), macro credit and risk management group and is a senior member of AMP Capital’s Credit Investment Committee.