“Fixed income” is investment-speak for bonds and bond-like investments. These are income producing vehicles that tend to have a fixed maturity date when the investor receives his or her principle investment back. They tend to be viewed as the conservative piece of an investor’s overall portfolio, complementing stocks, which are more aggressive and tend to have higher risk and higher return characteristics than bonds.
Many entities — including the U.S. Treasury, government agencies, corporations, municipalities, and others — issue bonds and other fixed-income instruments to raise capital. A bond can be thought of as a way to lend money to the issuer in return for an income stream and the eventual return of principal. These investments tend to be a portion of most investors’ portfolios, and they can be an important asset for individuals with income needs and those who wish to offset some of the volatility stocks can create.
At Bartlett, our approach to fixed-income investing is based on four guiding principles:
- We view interest rate fluctuation as random. We don’t attempt to predict the direction of interest rates, preferring to take a neutral stance over time.
- Extreme sentiments can present opportunities. In a cyclical bond market, certain areas can become overvalued and others undervalued. By opportunistically overweighting and underweighting these sectors, we can sometimes enhance return and/or reduce risk. For example, when corporate bonds sold off dramatically during the last recession, it created an opportunity to overweight the corporate bonds at attractive valuations.
- Fixed-income markets favor the issuer. Since bonds are created primarily to help the issuing entity raise money — not necessarily in response to investor demand — bond terms can be expected to slightly favor the issuer over the buyer at issuance. For this reason, we look for bonds that have been trading in the market after issuance, rather than purchasing bonds at the time they are issued.
- Intermediate maturity bonds carry greater risk/reward than long-term bonds. Intermediate bonds mature within 1-10 years, and long-term bonds have maturities much longer than 10 years. We tend to avoid the longer maturities unless they are exceptionally attractive. Bonds with longer maturities can be highly interest-rate sensitive, and historically, intermediate maturity bonds have offered a better expected return relative to their expected price volatility.
In addition to these four guiding principles, it is important to mention we want fixed-income investments to serve as the shock absorber of a portfolio during times when the stock market experiences large corrections. For this reason we don’t take a lot of big risks with our fixed income investments — a large overweight to low-quality or illiquid bonds, for example.
Investors should know what percentage of their total portfolio is allocated to fixed-income investments, and whether they are in line with their long-term targets. Sometimes, trading activity or rebalancing is required to get things back on track, especially in periods when stocks have performed well. The overall asset allocation of a portfolio will be the most important factor in influencing risk and return, more so than the innate differences between the underlying investments within these categories.
A thoughtful approach to fixed-income investing within a properly constructed total portfolio will help an investor weather many different types of market environments.