Investment funds: what is fixed income

For the more conservative savers and investors, fixed income products have always been one of the most attractive options, since they are instruments with a low associated risk and a profitability that, although reduced in comparison to other types of investments, is known for beforehand.

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

Types of fixed income

In the market, there are different fixed income products that can be classified according to who issues them, the term of the investment and the yield they offer. We are going to see all these classifications.

Fixed income according to the issuer

  • In the first place, we find public fixed income, that issued by States, Autonomous Communities and other Administrations or public bodies with the objective of financing their structural expenses and supplementing income from taxes. The public debt is traded on the Public Debt Book Market and is supervised by the Bank of Spain. Within this category are the Treasury Bills, Bonds, and State Obligations.
  • On the other hand, there is private fixed income, issued by companies that need financing to undertake projects or expand capital. This type of fixed income is traded on the AIAF market, under the supervision of the National Securities Market Commission. In this category, we find company promissory notes, bonds, and obligations of private companies, subordinated obligations, mortgage securitizations, mortgage certificates, and territorial certificates.

Fixed income according to the expiration term

  • We can find short-term investments in the money markets, where we mainly acquire Treasury Bills and Promissory Notes of companies, whose maturity has a maximum term of 18 months. This type of products have a very high liquidity, that is, they can be easily sold in the secondary market, although they have a lower profitability than longer-term investments.
  • Medium and long-term investments are made in the capital markets, where Bonds and Obligations are purchased from both private companies and Public Administrations. For these investments, the maturity exceeds two years and although they have a higher potential return than investments with shorter terms, they also have higher associated risk.

Fixed income according to the performance offered

  • Explicit return fixed income products are those that make periodic payments to the investor in the form of interest (coupons). The periodicity of these payments varies depending on what is stipulated in the issue, with the semi-annual or annual coupon being customary.
  • The products of implicit yield or zero coupons 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 products has a single interest payment at the time of amortization.

The risks of fixed income

One of the most common mistakes is to think that investing in fixed income does not have risks. It is important to emphasize that any investment product contains risk to a greater or lesser extent. These risks must always be detailed in the product’s brochure. It is basically three types of risks:

  • Issuer risk: the probability that the entity that issues the fixed-income securities does not return the money to its investors. To assess this risk, there are different rating agencies that give a ‘note’ to the company or Public Administration that wants to issue debt and finance itself in this way.
  • The risk in the changes of interest rate: it is the risk that the securities quote below the price that we paid for them at the time. The price of fixed-income securities depends to a large extent on the evolution of interest rates, market conditions, and general economic conditions.
  • Liquidity risk: this is the risk that in case of wanting to sell the fixed income security, we can find a counterpart in the market. That is, it measures how easy or difficult it will be for the investor to find buyers of their fixed income products in the secondary market.

The best way to acquire exposure to fixed income is through fixed income investment funds, where the manager is in charge of buying the best issues, diversifying and minimizing issuer risks, interest rates, and liquidity.