Fixed Income Selection Process

Driven by your investment plan, a percentage of your portfolio may be invested in bonds, or Fixed Income Securities. We use high-quality, intermediate term securities, which typically capture a significant portion of available yield with substantially less price volatility than longer-term bonds.

  • Overview

    • For many investors, fixed income (or bonds) is an important part of the investing equation. However, many investors misunderstand the roles that fixed income play in portfolios. The following discusses the proper use of fixed income.

      One of the most basic distinctions in investing is between equity and fixed income. While many investors know the difference between the two, it’s important to note the differing roles they play:

      • Equity is for wealth appreciation

      • Fixed income is for wealth preservation

      This is a simple, yet important distinction that ends up defining the purchases investors make with respect to each asset class.

      Historically, equity has had higher returns than bonds, but has also been associated with much higher risk. Thus, those seeking capital appreciation (or higher returns) tilt their portfolios more heavily toward stocks, as they have higher expected returns. However, a portfolio consisting entirely of stocks may not be appropriate for some investors for many reasons:

      • They may not have the ability, willingness or need to take such risk

      • They may be seeking a stable source of income

      • They may have a need for cash in the near future and must have ready access to their capital

      • They may have a shorter time horizon

      This is where fixed income has a role. There are three main uses for fixed income:

      • It is used to mitigate the risk of a portfolio and stabilize the portfolio

      • It provides a liquid source of capital should investors need it

      • It provides a steady income stream

  • Mitigating Risk

    • Equity has higher expected returns due to the higher risk involved with investing in the asset class. On the other hand, fixed income offers more stable expected returns. The price for this stability is lower expected returns.

      For investors who do not want the risk of an all‐equity portfolio, adding an allocation to fixed income helps dampen that risk. Generally speaking, portfolios with a higher allocation to fixed income experience less volatility than those tilted more heavily to equities.

  • Providing Liquidity

    • Oftentimes, investors have specific short‐term needs (such as paying taxes) or unexpected expenses and must have immediate access to their capital, thus needing it to be liquid. A defined maturity structure helps ensure funds will be available when those needs arise. The fixed income portion of their portfolios can be structured and tailored to meet both unforeseen liability needs and those that are planned. This can be done by shortening the maturities of high‐quality bonds and purchasing bonds that meet specific dates when the money will be needed. In the former case, such bonds can be easily sold with minimal market impact.

  • Providing a Steady Income Stream

    • Creating a structured laddered portfolio of high‐quality fixed income securities minimizes reinvestment risk, which is the risk of reinvesting money from maturing bonds into securities with lower interest rates. Building a portfolio with small portions maturing in any given year helps address reinvestment risk, thus keeping the income stream steadier.

  • What to Consider for a Bond Portfolio

    • Because the overall goal of the fixed income portion of a portfolio is stability, the fixed income instruments chosen should be of the highest quality. This means selecting fixed income instruments with the highest probability of accomplishing their intended goal.

      Credit quality is one of the first considerations. The lower the credit quality of a bond, the more likely the issuer is to default. Obviously, the higher the likelihood of default, the less stability in the portfolio, which defeats the purpose of adding an allocation to fixed income in the first place.

      It’s true that securities further down the grade scale provide higher expected returns. However, there are several issues with investing in high‐yield (or junk) bonds. Higher expected returns mean higher risk, certainly the case for junk bonds.

      Furthermore, such bonds have a higher correlation to equities, meaning they act more like equities and add volatility to the portfolio. For prudent investors, the goal of the fixed income portion of the portfolio is to dampen its overall risk, not increase it.

  • Process