This article first appeared in Personal Wealth, The Edge Malaysia Weekly on May 13, 2019 - May 19, 2019

Is it time to look at fixed income (bonds) as an investment option?

It could be, especially the Asian names.

Opportunities in the market aside, fixed income is the safety net during unforgiving market downturns for your investments. It is great for reducing volatility while paying out an income stream. For those who may not know, a fixed-income security is an instrument that allows governments, companies and other types of issuers to borrow money from investors (debt) to fund their plans. Hence, bonds are debt securities, similar to an IOU.

When investors invest in bonds, they are lending money to a company or government, which is known as the issuer. The issuer of bonds may use the money to finance their operations or investments. In return for the loan, the issuer generally pays the investor income at a specified rate and on a specified date during the life of the bond, and then the face value of the bond at maturity. Traditionally, bonds were confined to institutional players due to the large investment amounts — about RM5 million — required in Malaysia. However, today, with bonds made available to retail players, investors can invest with just RM1,000.

Because they lack ownership rights, fixed income securities might look unattractive compared to common shares.

On the flip side, they do have a higher claim on the company’s earnings and assets than the claims of common shareholders. Thus, a company’s fixed-income securities, in this way, have a lower risk compared to common shares.

They are nifty products because of what might be termed the stability factor. This is an important consideration, especially for those who experience “shaky legs” syndrome in times of volatile markets. The presence of some fixed income exposure has been found to help steady the shakes.

In portfolio management, fixed-income securities fulfil several important roles by providing a degree of safety, such as known future payments. The correlation of fixed-income securities to common shares varies, but adding fixed-income securities to portfolios, including common shares, is usually an effective way of obtaining asset class diversification benefits.

But do not jump for joy just yet — hammering safety into your portfolio is going to entail a lot more than just buying bond funds. Just how much of the bonds landscape you want to sample is a matter of personal inclination and tolerance for risk. If you like personalising your social media account, you can have some fun personalising your bond portfolio.

You can use bonds as a portfolio shock absorber in diverse ways, that is, how it is constructed can be tailored to you. But just how diversified your bond portfolio should be is a question that must be attended to. Alongside this, while diversifying is good practice, it is certainly not as simple as it sounds.

If you invest in multiple bond funds with wide manager discretion, make sure the manager does not invest in the same fixed income securities as it will defeat the purpose of diversifying altogether.

The risks? The further you go out on the yield curve or down the credit-quality spectrum, the more you lose the diversification benefits of bonds. Remember, we are trying to buff up the portfolio to take on potential market downturns. If the bonds you buy have a high correlation with stocks, it will defeat the purpose of diversification altogether. Unlike equity investments, I prefer not to have too many surprises for bond portfolios because surprises with bonds are almost always bad, and we have enough trauma from equities.

At this point, it is normal to hear the loud yawns in the background. This happens, I think, because many investors out there are masochists who do want some spark from their bond portfolios. So if you really insist, sure, I will address the workings on leverage in bond portfolios in my next article. However, for now, since retail bonds may now be purchased by retail customers or high-net-worth customers, I figured it would be great to ease you into the complexities of fixed income securities and bonds.

Do not be fooled by the simplicity of bonds and take them for granted, particularly when leverage is involved. But we’ll talk about that the next time round.

Michael Lai is vice-president of wealth management research at OCBC Bank (Malaysia) Bhd

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