Tuesday 24 February 2015 by Education (basics)

Does your portfolio need a refresh?

If you have a bond portfolio or are thinking about building one, check our list of eight key considerations across the risk and return spectrum.

fixed income written on chalkboard

The key consideration in constructing a fixed income portfolio is to identify the right balance of risk and reward and select appropriate investments to achieve that balance. Analysing an existing portfolio is a matter of revisiting that risk/reward balance to determine whether anything has changed in market conditions, investor risk appetite, or available securities.

Assess your risk

  1. Are you maintaining a good investment grade / sub-investment grade balance?
  2. Are you maintaining a good senior debt / subordinated debt balance?
  3. Does your portfolio exhibit good industry/issuer diversity?
  4. Is your portfolio appropriately balanced to minimise risk from interest rate and inflation changes?
  5. Are there any other risks in your portfolio (currency, mortgage backed security structures, call risk) and are they appropriate?

    high yield inv grade

Generally, I would recommend investors hold at least 60 to 70% investment grade bonds. These bonds are considered low risk and as such, you can hold fewer large investments. High yield bonds are higher risk and will help boost overall portfolio returns. However, given their higher risk I would suggest investors hold a greater number of securities to increase diversification and invest smaller amounts per bond.

Similar portfolio percentages of 60 to 70% should be allocated to senior debt. As you move down the capital structure, you need to make sure you understand the terms and conditions of the securities and that the returns on offer adequately compensate you for the risk you are taking. My preference is to hold a greater proportion of subordinated debt compared to hybrids.

capital structure diagram

The greater the diversification in a portfolio, the better the protection it offers. Diversification can be assessed by considering industry, issuer and types of bonds held in a portfolio. A common over-allocation is to the financial institutions sector, where investors have multiple investments across the capital structure including: term deposits, senior bonds, hybrids and shares.

Assess your returns

  1. Are you getting paid for the risk you are taking?
  2. Are you getting appropriate income?
  3. Can you get better returns for similar risk?

For further information about fixed income or FIIG, you can speak to a FIIG Relationship Manager by calling 1800 01 01 81 or email us to ask a question or set up an appointment at info@fiig.com.au.