Understanding and Investing in Fixed Income

Fixed income investments are often thought of as boring or uninteresting. Yet, this asset class forms a significant part of any credible investment portfolio and is, in most cases, the cornerstone of many balanced portfolios. Perhaps the misnomer surrounding fixed income stems from a poor understanding of this asset class and the role that it plays in the broader investment landscape. Through this article we unpack and demystify some of the obscurities surrounding fixed income and identify the remarkable opportunities and attractiveness that this asset offers.

Defining Fixed Income

Fixed income is a class of assets and securities that provides investors with a return in the form of fixed periodic payments over the life of the investment. This includes instruments such as government bonds, corporate bonds, inflation-linked bonds, securitised assets, credit-linked notes and various forms of what are known as money market instruments. Money market instruments can be anything as simple as a savings account or fixed deposit. Alternatively, they can be structured in the form of more sophisticated instruments such as negotiable certificates of deposit (NCD’s), promissory notes (PN’s) or treasury bills (TB’s). Each has their unique cash flow and payment profile.

The common thread running through the various fixed income instruments is that they all provide cash flows to the investor at regular fixed intervals at a specified rate, yield or spread. The rate or yield is, therefore, of paramount importance when assessing or valuing any fixed income instrument. Importantly, it is the directional movement of interest rates that determines the relative value of the investment.

Fixed Income Investment philosophy and process

At Cadiz Asset Management, our fixed income investment philosophy is simply to provide incremental outperformance over time within defined risk parameters.

Each fixed income portfolio is associated with a defined benchmark. It is this benchmark that specifies the overall performance target and goal for the fund. In keeping with our philosophy, it is the incremental outperformance of the benchmark that is always targeted. The compounding effect of incremental outperformance is significant and allows for an investment process that minimises variability of returns over time.

Our fixed income investment process has been designed to constantly define a level of conviction on the directional movement of interest rates. Once we have formulated a view on the direction of interest rates, we are then able to align the investments in the portfolios to the said view. Of equal importance is the sensitivity of these investments to the movement in interest rates. It is, therefore, required by the process to take sensitivity into account by analysing all factors that influence rates, including economic fundamentals, monetary policy, and the valuation of assets.