What is investing in fixed-income?

We'll explain what investing in fixed-income is and describe its main characteristics

Investing in Fixed-Income

The fixed-income market is the biggest financial market in the world, where governments, companies and local administrations go in search of financing. To do so, they issue debt securities in different forms (treasury bills, promissory notes, bonds, debentures, convertible bonds, etc.), all of which are known as fixed-income assets.

Vocabulary to be taken into account

  • Bond issuer: the entity that goes to the market to seek finance.
  • Bond buyer: the investor that lends the money. 
  • Coupons: the periodic interest payments that the bond investor receives. They can be paid at different frequencies: monthly, quarterly, half-yearly, yearly or at maturity.
  • Maturity date: the end of the loan term.
  • Principal: initial amount invested by the buyer of the bond, and which is recovered at the end of its term.
  • Duration: this is a measure of risk that indicates a bond's sensitivity to interest rate fluctuations. For example, if a bond has a 7-year term, it means that in the event of a 1% rise in interest rates, the price of the bond will fall by 7%, and vice versa. Therefore, the longer the term, the higher the risk of interest rate fluctuations.
  • Rating: a credit quality score assigned by the rating agencies, which reflects the solvency of the issuer being analyzed. The best credit ratings are referred to as investment grade, while the worst are known as high yield. 
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What is a bond and who issues them?

A bond is a loan that the purchaser or holder of a bond performs for a period of time. These securities establish at the outset a predetermined interest payment, which the issuer undertakes to pay to the investor periodically and on a set date such as at the end of the loan term, when the company returns the initial amount to the investor.

Although investors in fixed-income assets give a loan to debt issuers, it should be taken into account that “fixed-income” does not necessarily mean “fixed return” or risk-free.

If the bond is held until the loan's maturity, given that the return is known in advance, the risk for the investor centers around the possibility that the issuer may not fulfill their payment obligations. This is known as credit risk or insolvency risk.

During the bond term, its market value may fluctuate depending on interest rate movements, as well as on expectations regarding the issuer's payment capacity.

Why is investing in Fixed-Income appealing?

  • Periodic interest receipts.
  • Protection of the capital, since the initial amount of the investment is recovered at the end of the bond's term.
  • It's diversification, as this can reduce portfolio risk, as they can be combined with other assets such as equities.

How Fixed-Income funds are classified

Fixed-income used to be perceived by investors as a risk-free asset with which to receive periodic coupons. In recent years, however, the market has evolved such that we can find a very wide range of ways to invest within the fixed-income market, with varying levels of complexity. The strategy you wish to follow should be chosen depending on the risk you want to assume and the investment goals you wish to achieve.

Public debt and private fixed-income continue to be the two most important sectors of the bond market, although the way in which they are combined, together with other types of bonds such as mortgage securitizations, currencies or convertible bonds, make it necessary to differentiate funds into categories.

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The category into which a fund falls is determined by its risk factor or by the variables that can determine the fund's returns. Some examples in this regard are as follows:

  • Public or government debt of developed countries, which will be affected by interest rate fluctuations in different countries.
  • Credit. Focused on corporate issues, influenced mostly by the issuing companies' financial health, i.e. their payment capacity (credit rating). They are usually differentiated into two groups: investment grade (issuers with a high payment capacity) and high-yield (issuers with a lower payment capacity).
  • Inflation. In addition to interest rate risk, these issues are linked to inflation expectations.
  • Convertible. These are bonds that include a derivative instrument on shares, meaning that their performance can be affected by how equities perform.
  • Emerging. These are bonds issued by governments or companies of emerging countries. The market differentiates between securities issued in the main developed currencies (US dollar, euro, pound or yen), and issues made in the local currency of the country where the securities are issued (Mexican peso, Brazilian real, etc.). These bonds will be affected by each country's growth outlook, as well as by the fluctuation of their currencies.
  • Aggregate. These are funds that combine several or all of the factors described above.

Things to take into account when investing in fixed-income assets 

  • The payment capacity of the entity we are lending to is key. If it is not able to service the interest payments and to repay the amount lent in the prescribed term, the investor could lose part or all of their money. When investing through an investment fund, we are investing in various bonds of different issuers, thus this risk is spread out.
  • The term of the loan is also important. It is easier to know if the entity will be able to repay the funds within five years than within 30 years, as many events may occur during periods of such length. Depending on the objective of the fund, it will invest in longer or shorter terms.
  • There are agencies responsible for analyzing the different issuers and assigning them a credit rating according to their solvency. The most well-known agencies are Standard & Poor’s, Moody’s and Fitch. This allows us to compare different issuers using the same criteria. In the information sheets that fund managers generally prepare about their funds periodically, they publish the average rating of all the bonds in which the fund invests, together with other details of interest. If the management company has published this file, you can view it in the section "See documentation" within the fund's information at www.bbva.es
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