Fixed income diversificationSunday, June 13, 2021
BY Dwayne Hunter
Many investors often think of diversifying as having different investment managers and investing in different asset classes. However, there is also diversification within asset class which unfortunately is not considered enough by investors.
According to Investopedia, “diversification strives to smooth out unsystematic (unique to a company or industry) risk events in a portfolio, so the positive events of some investments neutralizes the negative performance of others.” It further states that “the benefit of diversification holds only if the securities in the portfolio are not perfectly correlated — that is, they respond differently, often in opposing ways to market influences.”
Having a properly diversified fixed income portfolio may be the best investment map for investors who prefer consistent growth and some amount of predictability. Investors can diversify their fixed income portfolio as follows:
1. Investing in bonds of different industries
2. Investing in a mix of bonds issued by growth and mature companies
3. Investing in an actively managed bond fund
Investing in bonds across different industries helps an investor to significantly reduce the risk of their portfolio. The effect is greater when there is little or no correlation between the industries. The goal here is identifying the industries that are oppositely affected by market influences.
Growth and Mature Companies
Bonds issued by growth companies often offer a higher coupon than those of mature companies because they are seen as riskier and as such have to compensate investors for their higher perceived risk. Many mature companies on the other hand are viewed as more stable, have predictable income, better fundamentals and track record. Investors are therefore more comfortable purchasing their bonds and are willing to accept a lower coupon.
The key here is proportion allocation of resources. If done properly fixed income portfolio can achieve reduce risk and higher return.
A bond fund is one that is managed by a fund manager who seeks to invest in a variety of individual bonds, thereby giving investors exposure to a larger universe of fixed income investments.
An actively managed fund offers remarkable diversification benefits for investors, even with a relatively small investment, and when managed well provides significant risk reduction and potential for above average returns. For example, there is a locally managed bond fund that has returned an average of over 11 per cent per annum since its inception 18 years ago. A person who invested US$10,000 at the start of the fund would have over US$76,000 today.
These bond funds are best suited for investors who are not seeking income and are more interested in growth over the medium to long-term. They are a complement to any investment portfolio and should be highly considered when planning for pension, education, a house purchase, etc.
Having a properly diversified fixed income investment portfolio provides great benefits for investors and plays a major role in managing and creating generational wealth.
Have a talk with your investment manager about constructing an efficient, diversified fixed income portfolio.
Dwayne Hunter is the AVP, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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