Assessing risk in fixed interest investments

When considering income investments it is important that investors understand the risk profile of the securities they are investing in.

Fixed interest investments are considered a low-risk investment, which provide a regular income stream and buffer against sharemarket volatility in diversified portfolios. There are a multitude of fixed interest securities available offering a choice of maturity structures and risk/reward profiles.

Often the quality of the issuer can be forgotten when high yields are on offer. This is exactly what happened in the US sub prime market where loans made to high risk debtors were bundled and issued to investors.

This is why it is important to understand the quality of the assets and issuer backing the security. Fixed interest investments can be issued by the Commonwealth Government, state governments, semi-government authorities, banks and other corporations, both locally and overseas, to raise capital for projects. Credit ratings provide a good indication of the risk level and quality of the issuer.

Some investments in the fixed interest spectrum, such as hybrids, display more growth asset characteristics and perform more like shares. While the returns on these investments can be much higher than traditional fixed interest investments, so can the risks. Fixed interest investments should perform differently to growth assets. After, all this is part of the reason for investing in them in the first place.

Another aspect of fixed interest investment is interest rate risk where changes in interest rates can impact the value of the security. If you hold your bond until maturity interest rate risk is less of an issue. You will receive set income payments at the agreed interest rate for the life of the bond and your capital is repaid when the bond matures.

The maturity of the security can also impact the risk profile of a security, usually the longer the term the higher the risk and the yield on offer. Australian bond maturities range from one to 10 years while US bonds can extend up to 30 years.

Managed funds provide a way of accessing a diversified portfolio of securities, which can include a mix of Australian or international government and corporate fixed interest investments, or a combination of both. Diversifying across securities can mitigate security specific risk, particularly if the fund invests in high quality securities.

While fixed interest doesn’t deliver the highs of shares or property trust investments, it doesn’t suffer the lows that shares and property trusts can in more volatile times. This, in addition to its regular income, is the major benefit of investing in fixed interest.