In addition to other advantages, bond funds and bond ETFs provide better diversity than individual assets. Since they invest in a variety of assets as opposed to stocks, bond funds are similar to stock funds in that they own fixed income instruments. This simplistic approach to income investing demonstrates how uninformed investors and some advisers have become. It is not necessarily their fault though, there isn’t a developed platform for trading a broad range of diversified income securities in Australia nor sufficient market education.
The following are the main causes of low fixed interest allocations:
Benefits
increased potential income – In contrast to money market funds (which prioritise retaining the value of your investment) and stock funds, bond mutual funds and bond ETFs provide your portfolio with the possibility to generate income (which aim for long-term growth).
Strengthen your portfolio’s stability – Bond funds can assist balance the risks associated with stock funds when they are a part of a well-balanced portfolio. Bond funds that are inflation-protected might also assist you in keeping up with inflation. These funds regularly account for inflation and invest in government bonds.
Aid in reducing investment risk – A single fixed income mutual fund or exchange-traded fund (ETF) may own hundreds or even thousands of bonds. More diversity is obtained than if you only owned a few different bonds.
You may choose funds that are appropriate with your overall risk tolerance by being aware of the broad characteristics that are used to categorise the various bonds within a bond fund.
Typical maturity Short-, intermediate-, and long-term maturities are available for bond funds. The fund is more susceptible to fluctuations in interest rates the longer the term.
Credit standing. The “credit rating” of bonds backed by the government or one of its agencies is the highest, and they are less likely to default than most business bonds. Investment-grade corporate bonds are those with a high credit quality, whereas high-yield (or “junk”) corporate bonds are those with a lower credit rating.
Risks
Investors in fixed interest securities are more concerned with timely interest payments and the return of capital at maturity than equity investors, who are more focused with growth and less tolerant of volatility. Hence, the risk that the borrower may not fulfil any of these issuer duties is what fixed income analysts concentrate on.
Since that bank hybrid securities dominate the ASX interest rate market, it is worthwhile to examine the usual capital structure of the largest banks.
The largest banks attempt to abide by Basel III’s global standard ratios while also being subject to APRA’s capital adequacy standards (i.e., regulatory capital ratio), which are applicable to all financial institutions. Holders of term deposits would be safeguarded in the unlikely case of a banking crisis or a share market crash, but holders of hybrid securities issued by a bank would be converted (or written off) to cover any unanticipated losses. Investors in Tier 1 hybrids (highlighted) currently enjoy rights similar to those of owners of common stock, and a collapse might result in the loss of their investment.
The mentioned scenario may be harsher for corporations with substantially geared balance sheets, and A REITS with high LVRs would also be impacted.
Any advice provided by Investor Desk is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
