The Weird & Wonderful World of Fixed Income

Fixed income investing has long been seen as the sober counterpart to the wilder ride typical of equity investing. Investors generally invest in fixed income with the expectation of reliable income returns and capital preservation.

But beyond the traditional world of government bonds, investment-grade corporate bonds, and high-yield bonds, there exists a lesser-known but growing realm of fixed income strategies worth being aware of. Each brings its own blend of risk, reward, and reasons for consideration or avoidance…

1. Hybrids & Convertibles: The Fixed Income Chameleons

What they are:

Convertible bonds and hybrid securities straddle the line between debt and equity. Convertibles offer bond-like income with the potential for equity upside if the issuer’s stock performs well.

Hybrids, often issued by financial institutions, may be perpetual in nature and come with conditional features, such as coupon deferral or capital conversion in times of stress.

Why consider them:

Convertibles provide a capital floor plus the optionality of equity upside. They can be attractive in transitional markets or with high-quality issuers in emerging sectors. Hybrids, meanwhile, can offer higher yields than traditional bonds, albeit with greater complexity and risk.

Why to be cautious:

These types of instruments are structurally complex and can behave unpredictably.

For example, convertibles are sensitive to both interest rates and stock volatility, while hybrids may lose value quickly in a financial downturn, especially if their coupon payments are suspended.

Investors should understand the embedded risks and covenants before investing.

Best for:

Sophisticated income seekers who are comfortable with credit and equity risk and want diversified exposure to different market drivers.

An Example:

2.Managed Income Portfolio Services: The Human Touch in Fixed Income

What they are:

Managed Income Portfolio Services are professionally managed accounts where fixed income strategies are actively curated to meet an investor’s income, risk, or tax objectives. Think of them as personalised portfolios blending various bond types, sectors, and durations, often across multiple geographies.

Why consider them:

They offer a level of flexibility and customisation rarely found in off-the-shelf funds. For investors who are navigating complex financial situations such as high income, tax sensitivity, or varying liquidity needs, a managed income service can tailor duration, credit exposure, and yield to fit their precise goals.

Why to be cautious:

The fees for this type of service are often higher than for passive alternatives, and performance varies depending on the manager’s skill and strategy. Transparency can also be limited, particularly in separately managed accounts. It’s critical to evaluate the manager’s track record and risk framework prior to investing.

Best for:

High-net-worth investors who value bespoke solutions, especially those seeking income with tax optimisation or diversification across private and public credit markets.

An Example:

3. Cash Fund-of-Funds: Enhanced Liquidity

What they are:

Cash Fund-of-Funds are pooled vehicles that allocate capital across a range of short-term or money market funds, aiming to optimise yield while maintaining liquidity. Essentially, they’re funds comprising other cash or near-cash instruments with the goal of greater diversification within a conservative allocation.

Why consider them:

A fund-of-funds structure provides an added layer of diversification across cash fund providers, instruments, and geographies, while retaining daily liquidity.

Why to be cautious:

While the associated risks are low, they are not zero. Concentration risk, counterparty exposure, and potential fee layering (fund-of-fund fees on top of base fund fees) should not be overlooked. During a liquidity crunch, redemption delays or pricing anomalies may occur, though this is rare.

Best for:

Conservative investors, corporate treasurers, or anyone looking to maximise their return on cash holdings without locking up capital or significantly increasing risk.

An Example:

4. Real Income Funds: Inflation’s Navigator

What they are:

Real Income Funds are designed specifically to deliver inflation-adjusted income through assets like inflation-linked bonds (e.g. TIPS), real estate securities, infrastructure debt, and floating-rate instruments. Their objective is to maintain or grow investors’ purchasing power over time.

Why consider them:

Inflation, once considered transitory, has proven to be more durable than expected. For income-focused investors, especially retirees, the resultant erosion of purchasing power can be devastating. Real income funds are structured to protect against this, often by diversifying across both public and private inflation-sensitive assets.

Why to be cautious:

Inflation-linked securities can underperform if inflation expectations fall, or if real yields rise sharply. Many real income funds also include alternative assets with longer lock-up periods or higher volatility. As such, these funds may not be as safe as traditional fixed income funds in the short term.

Best for:

Long-term investors concerned about inflation erosion who are willing to accept some complexity and illiquidity in exchange for better real income prospects.

An Example:

The Fixed Income Frontier is Expanding

Fixed income, once viewed as a one-dimensional asset class synonymous with safety and predictability, now includes a growing range of niche funds.

However, with greater choice comes greater responsibility. These unconventional fixed income funds can offer real benefits such as diversification, yield enhancement, inflation protection, but they also require understanding and a higher tolerance for nuance. Before investing, investors should carefully assess their risk tolerance, time horizon, liquidity needs, and overall portfolio context.

In the weird and wonderful world of fixed income, knowledge is the real yield.

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.