Investment funds: what is fixed-income

Reduced risk and a previously known return are two of the characteristics of a fixed-income investment

For more conservative savers and investors, fixed-income products have always been one of the most attractive options, as they are instruments with low associated risk and a return that, although reduced compared to other types of investments, is known in advance.

That said, what do we mean when we talk about investing in fixed income?

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Types of fixed income

There are different fixed-income products on the market that can be classified according to the issuer, the investment period and the return they offer. We will look at all these classifications.

Fixed income according to issuer

  • Firstly is public fixed income, which is issued by States, Autonomous Regions and other public administrations or bodies with the aim of financing their structural expenses and rounding off tax income. Public debt is quoted on the Public Debt Market represented by account annotations and is supervised by the Bank of Spain. Within this category we find Treasury Bills, Bonds and Government Securities.
  • On the other hand is private fixed income, which is issued by companies that need financing to undertake projects or increase capital. This type of fixed income is quoted on the AIAF market under the supervision of the National Securities Market Commission. In this category we find corporate promissory notes, bonds and securities issued by private companies, subordinated debentures, mortgage securitizations, mortgage bonds and public sector bonds.

Fixed income by maturity date

  • Short-term investments are found in the money markets, where treasury bills and company promissory notes are acquired, which mature in up to 18 months. This type of product has a very high liquidity, which means you can sell them easily on the secondary market, although the returns are lower than those of longer term investments.
  • Investments at medium and long term are made in the capital markets, where Notes and Bonds are bought from private companies and public administrations. For these investments, the maturity is more than two years and although they have a potentially higher return than shorter- investments, the associated risk is also greater.

Fixed income according to the return offered

  • Fixed income products with explicit returns are those that make regular pay-outs to the investor in the form of interest (coupons). The frequency of these payments varies according to what was stipulated in the issue, although it is usually in half-yearly or yearly coupons.
  • Implicit return or zero coupon products are those in which profitability is determined by the difference between the price paid by the investor for the product and the price at the time of amortization. This type of product has a single interest payment at the time it is redeemed.
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The risks of fixed income

One of the most common errors is to believe that there is no risk involved in investing in fixed-income. It is important to stress that any investment product involves risk to a greater or lesser extent. These risks should always be specified in the product issue brochure. There are basically three types of risk:

  • Issuer risk: the likelihood that the entity issuing the fixed-income securities will not return the money to its investors. To assess this risk, there are different rating agencies that rate the company or public administration that wishes to issue debt and finance itself in this way.
  • Risk of changes in interest rate: the risk that the securities will be quoted at below the price originally paid for them. The price of fixed-yield securities depends to a great extent on the evolution of interest rates, market conditions and the general economic conditions.
  • Liquidity risk: the risk that in the event of wanting sell the fixed-yield security we may not be able to find a purchaser in the market. In other words, it assesses the difficulty the investor may or may not have in finding buyers for their fixed-income products on the secondary market.

The optimal way to acquire exposure to fixed income is through fixed-income investment funds, where the manager is in charge of purchasing the best issuances, diversifying and minimizing issuer, interest rate and liquidity risks.

In short, before investing in fixed-income securities, we should always focus on:

  • The interest rate and payment frequency.
  • The issue and reimbursement prices.
  • The repayment date and conditions, as well as the early amortization conditions.
  • Whether or not it is quoted and, if so, in which market.
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