Investors rushed to less volatile bond funds in May, preferring fixed income investments over riskier equities, according to the latest figures from the Investment Management Association (IMA).
Around £490 million was invested into bond investment funds, accounting for 45% of all money invested in May 2011. Just over £340 million was invested into the Strategic Bond sector, while almost £140 million was poured into Global Bonds.
Surprisingly, just £64 million was invested in equities, down from over £1.1bn the previous month (the height of Stocks and shares Isa season) – suggesting that investors were shying away from the stock markets.
With this in mind, Which? Money gives you the lowdown on fixed income investments, how they work and what to look out for.
What are fixed income investments?
Fixed interest investments are effectively loans to different bodies, be it companies or governments, which pay you a regular income in the form of interest for a set period of time, after which your loan must be repaid.
They are designed to pay you a steady income and not necessarily growth on your investment. The most common forms of fixed interest investment are gilts and corporate bonds.
What’s the difference between gilts and corporate bonds?
A gilt is the type of fixed interest security that is issued by the government if it wants to raise money. They can be bought directly from the Debt Management Office and are generally seen as very low risk. This is because it is highly unlikely that the UK government would go bankrupt and therefore be unable to pay the interest due or repay the loan in full.
Corporate bonds are issued by companies that are looking to raise capital and are seen as riskier than gilts. You get a higher rate of interest for taking on this risk.
How do fixed income investments work?
A conventional gilt might look like this – “Treasury stock 8% 2015.” This shows the department that is issuing the gilt (the issuer), the rate of interest that will be paid (called the ‘coupon’) and when the loan will be repaid (called the ‘redemption date’). If the Government wanted to raise £100m pounds, it would issue one million gilts at the value of £100 each, known as the ‘nominal value.’
If you buy £1,000 worth of gilts, you would receive 8%, £80, every year for the next five years, until your £1,000 loan was repaid in 2015. The income you receive is called the ‘income yield’, ‘running yield’ or ‘interest yield’ and is paid twice a year (4% or £40 every six months, in this instance).
The coupon is determined by the length of time you must wait for maturity and/or the riskiness of the company within which you invest. The further away the redemption date, the higher the interest you will receive as you are having to wait longer to be repaid. Similarly, the greater the risk you take on a company, the higher the interest rate you can expect to receive.
Are gilts and bonds always bought for the nominal value?
In the majority of cases, no. Like shares, gilts and bonds can be traded, and their value can fluctuate based upon interest rates and the solvency of the issuer. Bond prices will rise when general interest rates are low, because the rates of interest they pay are fixed and will beat the short-term rates available from bank savings accounts.
Conversely, during the recession, the value of many corporate bonds plummeted amidst the fears that companies like banks and retailers would fail or go into administration. Prices will also fall if interest rates rise.
What are fixed income funds?
Fixed income funds are collective investment schemes, like unit trusts and Oeics, that invest in a range of fixed income investments. They invest in a great number of gilts or bonds to spread risk (or diversify), and aim to produce an income yield for you, paid four times a year. Investing in a fund like this does put your money at risk.
Gilt funds invest in gilts, whereas bond funds invest in corporate bonds.
There are four types of bond fund:
- Corporate bond funds: These invest mostly in bonds issued by high quality companies in the UK.
- Global bond funds: These invest in bonds by high quality companies around the world.
- Strategic bond funds: These invest in a mix of bonds, issued by higher quality and lower quality companies. They’re seen as riskier than corporate bond funds.
- High Yield bond funds: These are the highest risk bond funds. They invest in lower quality companies, but tend to pay a greater return for the greater risk you take on by investing in them.
To learn more about investment funds read our guide to the different types of investment.
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