Many investors have noted how when market volatility reaches a high, investing in some of the fixed income options with a diversified investment portfolio will pay the biggest dividends. This happens because fix income will almost always be correlated negatively to the more volatile asset classes. Still, it has been known to break down on different occasions. This especially happens when the market goes through abnormal conditions or stress.
Why Exposure to Fixed Income is Necessary
Adding bonds could have hidden benefits. In fact, fixed income will almost always be one of the important keys to having an investment portfolio that is also balanced. This could be said to have as much importance as the risk that comes embedded with a portfolio. This includes credit, equity and alternative assets. In addition, investors may want a little element of liquidity, which translates to cash.
The Key Reason for Exposure to Fixed Income
People must understand the key reason to expose oneself to fixed income has less to do with the correlation and more to do with having a high degree of predictability with cash flow. The predictability will give individuals the necessary volatility-dampening effect for those hard times that are often associated with correlated volatility. Investment managers will often discuss a term known as, “carry.” It has frequently been used to discuss the different elements of performance attribution. For those involved in the fixed income world, carry could also mean another term for coupon cash flow. The investor will receive this from the fixed income investments that were made.
Volatility Dampening Benefits
Investors often choose this because of the volatility dampening benefits of putting it into an investment portfolio. This can be seen in the following example. In a comparison to the total return performance with the Commonwealth Bank of Australia, shares are taken against a CBA senior bond. The bond pays a 3.895 percent semi-annual coupon. This will be simulated as a simple class for multi-assets. The performance will be seen in the senior bond and the equity of a portfolio of 50:50. Because of the CBA senior’s bond, the bond will experience standard deviation at four times less than the CBA equity. The CBA shares will result in this standard deviation that becomes halved.
Why Would an Investor Want Bonds at All?
As an asset class, the characteristics of bonds look so dismal that most investors wonder why invest in them at all? The advantage of bonds is how they mature on schedule, which will allow them to match the assets of an expected requirement.
Individual investors seek to maximize their return on their investment, while keeping the risk at an all-time low. Bonds can play two important roles in a person’s asset allocation plans. First, it lowers the risk to a more tolerable level for an individal’s portfolio. Second, it provides them with repository value where they can fund the future expected flows. Some people take a negative view of bonds, but they do have their benefits.