Fixed income as an asset class encompasses a variety of securities, including bills, notes, and bonds (collectively referred to as bonds henceforth), syndicated loans, and structured products.
Bonds can further be subdivided into government bonds, agency bonds, and corporate bonds. The bonds issues are rated by credit rating agencies on a 20-point scale from AAA to D, AAA being the safest and D and in default. The bonds rated BBB- and above are known as “investment-grade,” while the remaining bonds are known as “speculative-grade” or “high yield.”
Treasuries are government debt issued by the Department of Treasury with various maturities ranging from two weeks to 30 years. While only primary dealers are allowed to bid in the auction for Treasury securities, retail investors can invest in ETFs such as the iShares 20+ Year Treasury Bond (TLT), which in turn invests in Treasury securities.
Corporations issue bonds for various reasons, including acquisitions, capital expenditure, and refinancing. Hospital Corporation of America (HCA), with market capitalization of $21.6 billion, tapped the bond market last month to raise $3 billion. The deal was a two-part offering to refinance the company’s existing notes split between five-year and ten-year BB-rated tranches.
Syndicated loans are loans issued by commercial banks. Unlike bonds, the loans are amortizing securities, meaning they’re repaid in periodic instalments, mostly likely monthly. The loans are further classified into investment-grade and leveraged loans and are rated on the same scale as bonds.
Structured securities are securities derived from underlying assets such as mortgages, credit card receivables, and so on. Certain ETFs like the iShares Barclays MBS Fixed-Rate Bond Fund (MBB) exclusively invest in mortgage-backed securities, while some ETFs such as the AllianceBernstein Income Fund, Inc. (ACG) invest in Treasuries, corporate bonds, as well as mortgage-backed securities.
Treasury bonds surge when the economy is down due to a perceived investor flight to safety. As the economy starts improving, investors start moving towards riskier assets in anticipation of better risk-adjusted returns. Corporate bonds tend to exhibit similar patterns to equities, as the risks to bondholders reduce with increasing cash flows, which is also a positive for equities.
To learn about how the world economy has affected fund flows for equity ETFs over the past week, read on to Part 3 of this series.