The pros and cons of fixed income investments

What you’ll learn:

• How fixed income investments work.
• What the main advantages and disadvantages are.
• How to add fixed income to your portfolio.

Fixed-income investments are often a popular choice among investors hoping to generate steady returns, especially when even the highest paying savings accounts are failing to keep pace with the cost of living.

Set against a background of increased investor uncertainty towards shares in the last three years, bond funds have seen a surge in popularity since the start of 2016, with net sales of £27.6bn to September 2019, according to the Investment Association¹ (IA), the trade body that represents fund management groups To put these sales into context, over the same time investors sold a net £15.5bn from UK share funds as concerns over Brexit have loomed over the region.

How fixed income investments work

Fixed income investments focus on providing a reliable stream of income. The most common fixed income investments are usually bonds, which are fixed term loans issued by companies and governments looking to raise money. UK government bonds are called Gilts, whilst in the US government bonds are known as Treasury Bills, or T-Bills, and German federal bonds are referred to as Bunds.

A bond issuer will pay investors a fixed rate of interest for a set period, at the end of which the loan is repaid. Investing in individual bonds can be particularly risky, as their fortunes rely on the specific issuer, whether a corporation or government, and therefore in case of insolvency (or political events) they may fail to repay your investment and you could lose money.

As a result, many investors opt to put their money into funds that invest in bonds. This helps reduce the risk because rather than just buying bonds from a single issuer, your money is spread between range of different fixed income holdings. Some bond funds will invest solely in a basket of bonds issued by companies, while others will focus purely on government bonds, and some will invest in a combination of these. As with all investments the rule of thumb is that the higher the potential return on offer, the riskier the investment. Bonds which are rated from AAA down to BBB by credit ratings agencies such as Standard & Poor’s or Moody’s are classified as ‘investment grade’ and are deemed to be lower risk.

Generally, fixed-income investments are considered less risky than shares, with income from bonds being paid out before any dividends on shares, and bond payouts taking priority over shareholders in the case of insolvency.

Bonds can usually be sold before their maturity date but their market value will change over time, and may be affected by any fear of a government failing to repay or a particular issuer facing financial difficulties. The perception of the issuer’s ability to pay will reduce the value of the bond, which is also affected by credit agency assessments and ratings. This means that when you sell your investment in the market you may get back less than you originally put in. The value of a bond will also be affected by changes in general interest rates – see below.

Find out more about investment bonds and gilts

Outlook for fixed income

Despite positive performance for all fixed income assets in 2019, Will Hobbs, Chief Investment Officer at Barclays Investment Solutions, is cautious on the near-term outlook, citing concerns over the price of many bonds.

He said: “The safety from high quality government and corporate bonds potentially becomes more valuable when investors perceive the chances of a recession to be higher. Essentially investors are more prepared to pay for the insurance a bond may provide in the event of a recession."

“There is something in this theory. We continue to hold some bonds in most of our multi asset class funds and portfolios to provide some offset to other more economically sensitive assets. Nonetheless, we believe the risk of an imminent recession is being overestimated and that that is part of the reason why we are currently holding less in the asset class.”

A major theme of 2019 was a trend downwards in developed market interest rates, with the US Federal Reserve cutting rates by 0.25% on three separate occasions. However, Hobbs thinks this may reverse before too long.

He said: “If the global economy stabilises and possibly even accelerates over the next 12 months, which we expect it will, the global central banks at some point will get back to rising interest rates again at some stage soon.”

Higher interest rates typically reduce the value of existing bonds that carry lower rates, since the new bonds will be issued paying higher returns and hence will be more attractive. This weakens demand for lower-interest bonds. Lower interest rates, however, push up the value of existing bonds, because returns from them can be more attractive than existing bonds and those offered by cash accounts.

How to invest

If you’ve decided you want to invest in gilts or company bonds, you can do this directly via Smart Investor.

Whilst you can invest in gilts in small quantities, corporate bonds often have higher minimum investment amounts and are generally traded in multiples of 1,000 which can make it harder to invest unless you are investing significant sums.

While the interest rate offered by corporate bonds will typically be higher than gilts, it’s important to remember that that they come with more risk, given that a company is more likely to default on payments than the UK government. It’s therefore essential to thoroughly research the underlying company before investing.

Building a diversified portfolio of bonds and gilts can also be expensive if choosing individual investments. Because of this many investors choose to invest via a bond fund, which will hold a wide variety of fixed income assets to help spread risk.

Bear in mind that how much exposure you want to fixed income will depend on what you expect to happen to interest rates and the economy, but if you’re unsure, you should seek professional financial advice.

There are a number of bond fund options on the Barclays Fund list, including those that invest in corporate bonds, high yield bonds and strategic bond funds, which are those that invest across multiple bond asset classes.

See our list of funds

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.