Fixed income is frequently summarised by a single figure. That figure describes the income a holding is contracted to pay if nothing goes wrong. It says nothing about how the holding will behave if rates move, if credit conditions deteriorate, or if the position needs to be sold before maturity.
The variables that matter
Three characteristics explain most of the behaviour of a fixed income allocation, and they can be adjusted independently.
- Duration: sensitivity to interest rate movements, and the reason bond prices fall when rates rise.
- Credit quality: the probability that contracted payments are made, assessed at issuer level rather than by rating alone.
- Liquidity: whether a position can be sold in the size required, at a price close to its marked value.
Purpose determines structure
An allocation held for defensive purposes against equity risk looks different from one held to generate income, which looks different again from one held as a liquidity reserve. Combining all three objectives into a single sleeve usually means none of them is served well.
Where a higher yield is on offer, the sensible first question is which of these three characteristics has been given up to obtain it.
This note is general information about investment process. It is not investment, legal or tax advice, not a recommendation, and not an assessment of suitability for any particular investor. Investment involves risk, including the possible loss of capital.