EOFY Portfolio Reviews to Optimise Your Bond Portfolio

As the financial year draws to a close, it's the perfect time for investors to review their bond portfolios. When properly constructed, bond portfolios can provide income, total return, and diversification for investors. Bonds offer a range of options, just like equities, with varying levels of risk and yield. One of the advantages of owning individual bonds is the ability to tailor your portfolio to meet your specific needs and expectations.

By selecting individual bonds, clients can customise their portfolio according to their income requirements. At IAM, we assist clients in constructing fixed-income portfolios that meet their income needs and provide diversification. Diversification is crucial to the success of any fixed income portfolio. Spreading risk across a range of individual investments helps mitigate the impact of unforeseen events on capital.

To achieve diversification, investors need to have access to a wide range of fixed income securities. At IAM, we assess fixed income securities trading in all currencies, across listed exchanges and investment grade and high yield markets globally. This approach ensures that investors can evaluate relative value, diversify their portfolios, and access opportunities in different markets.

When constructing bond portfolios, IAM considers several factors to ensure diversification, manage credit risk, assess interest rate risk, evaluate liquidity, and account for foreign exchange (FX) exposure. Each of these factors contributes to the overall risk profile and return potential of a bond portfolio. Additionally, fixed income investments offer the ability to manage cash flows through interest payments, which can be beneficial for clients looking for a particular income stream.

Here's a breakdown of each factor:

• Diversification: A well-balanced fixed income portfolio aims to diversify across various factors, including maturity dates, issuers, ratings, and instrument types. By spreading investments across different securities, sectors, and geographies, the portfolio reduces the risk of concentration in a particular area and improves long-term performance.
• Credit risk: IAM looks at credit ratings provided by agencies like S&P, Moody's, and Fitch as a starting point. Bonds rated BBB- and above are considered investment-grade, indicating a lower risk of default. Global default rates for investment-grade bonds have historically been very low, providing added stability to the portfolio. IAM Capital Markets provides internal credit opinions from our Credit Strategy team and independent research reports from our research partner, BondAdviser, for all the bonds included in the portfolio.
• Interest rate risk: This factor is particularly relevant for fixed coupon bonds. Bonds with longer maturities and fixed interest rates are more sensitive to changes in interest rates. For example, Australian government bonds may have a high credit rating (AAA) but carry significant interest rate risk. On the other hand, floating rate notes have shorter interest rate duration as they reset their cash flows periodically, reducing their exposure to interest rate fluctuations.
• Liquidity: IAM takes into account the liquidity of bonds when constructing portfolios. Liquidity refers to the ease of buying or selling a bond in the market without significantly impacting its price. Larger issuance sizes typically correlate with better liquidity. However, during times of market stress or crises, bond market liquidity can decrease. Investors mitigate liquidity risk by considering the maturity date of the bonds, as it provides certainty regarding the repayment of capital.
• FX exposure: IAM offers access to bonds denominated in foreign currencies such as USD, GBP, and EUR. Foreign exchange fluctuations can impact the returns of individual bonds when converted back to the investor's base currency. The FX exposure adds another dimension to the overall risk and return profile of the portfolio.

By carefully considering these factors, IAM aims to construct bond portfolios that achieve diversification, manage credit and interest rate risks, account for liquidity considerations, and provide exposure to foreign currencies. This approach helps optimize risk-adjusted returns and aligns with clients' investment objectives and preferences.

As the financial year comes to a close, we encourage clients to contact their IAM Relationship Manager for a portfolio review. Taking this opportunity to review your portfolio will help ensure it continues to meet your needs effectively by maintaining suitable diversification and seeking to maximise returns while staying within your risk tolerance.

- Jenna Hayes née Labib

Disclaimer: (c)Income Asset Management Group Limited ACN 010 653 862 (ASX:IAM) and wholly owned subsidiaries., IAM Capital Markets Ltd ACN 111 273 048 AFSL 283119, IAM Cash Markets Pty Ltd ACN 164 806 357 as corporate authorised representative (no. 001295506) of AFSL 283119, Trustees Australia Limited ACN 010 579 058 AFSL 260038 and IAM Funds Pty Ltd ACN 643 600 088 as corporate authorised representative (No. 001296921) of AFSL 260038, together the IAM Group. Before making any decisions in respect to a financial product, you should read the relevant Financials Services Guide and Product Disclosure Statement and seek independent and specific advice from an appropriately qualified professional.