Fixed income risks
Comparing fixed income versus equities still tends to show the former as a lower risk option overall. However, fixed income seek to provide opportunities across the risk/reward spectrum to position portfolios for different environments and generate varying levels of income and potential return.
Bond prices usually move in the opposite direction to interest rates, so when rates are rising, bond prices may fall, and vice-versa. This is because bonds are riskier than cash, so investors need the incentive of higher rewards to use cash to buy bonds. When interest rates are low, demand for bonds is higher which pushes up prices – and vice-versa.
There is a risk that the issuer of the bond will default on its debt by failing to pay investors what it owes them. This risk varies with the credit-worthiness of the issuer and is reflected in their credit rating. Investors who take more risk by investing in lower rated issuers have the potential to achieve higher reward, and vice-versa. Issuers with a higher credit rating are considered ‘investment grade’ while those with a lower credit rating are considered ‘high yield’.
Liquidity risk is a measure of how quickly an investor could turn an asset into cash, if they needed to. In market environments where liquidity is low there is a risk that if a bond holder wanted to sell the bond, they may have difficulty finding a buyer, especially at a good price.
Inflation – the rate at which the prices of goods and services increases – can be a risk if the level of inflation is higher than the level of income made on savings and investments. The income paid by bonds is fixed so when inflation is rising, that level of income may be less appealing and bond prices tend to fall – and vice-versa.