The role of Australian fixed income strategies remains crucial to investors of all ages and all sizes, yet as an asset class it is possibly the least well understood. Legg Mason dispels some of the myths.

In the final part of its series ‘Income Solutions for Life’ the big multi-affiliate manager Legg Mason Global Asset Management says that the diversifying and defensive aspects of Australian fixed income make for an integral part of most portfolios, notwithstanding the likely direction of interest rates.

As with other asset classes, not all fixed income securities are the same and active managers can exploit market inefficiencies.

The paper, ‘Understanding Fixed Income’, says: “As an income investor it is important to be clear on the role you expect your fixed income exposure to play within your overall investment strategy.

“The universe of bonds available to invest in comprises a far wider risk spectrum than many investors may realise. The higher-risk sectors of the fixed income universe, such as corporate bonds 
or emerging market bonds, offer superior income returns compared to the lower-risk sectors, such as government bonds.

“The reason is simply that the bond issuer has to compensate investors for the higher risk of them failing to make the payments due in future be it the regular interest payment and/or repayment of the principal at maturity. These riskier bonds therefore tend to exhibit greater volatility and can be more correlated with equity market returns.”

It is important, therefore, to ensure that you understand the type of fixed income fund you are investing in, as not all strategies may provide the defensive characteristics that an investor might traditionally expect to receive.

For income investors in particular, diversification remains important. The fixed income allocation is designed to provide the defensive exposure within a diversified income strategy. Put simply, it provides downside protection and capital protection when growth markets, such as equities, are under stress.

For the previous papers in the series, go to: http://www.leggmason.com.au/income-solutions-for-life/