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Q What fixed-income strategies have been popular in the past

few years?

A For conservative investors, US Department of the Treasury

and government agency or govern-ment-sponsored enterprise bonds – such as the Federal Home Loan Bank, Small Business Administration, Fed-eral Home Loan Mortgage Corp or Government National Mortgage As-sociation – are popular. US govern-ment backing and liquidity makes these investments attractive. Large institutions, foreign governments and banks invest in these securities for capital preservation.

Then there are municipal bonds, which are issued by state and local municipalities. These bonds may be issued for particular projects (reve-nue bonds) or may be backed by the entire tax base of the municipality (general obligation bonds).

Generally, municipal bonds are considered conservative invest-ments. While the overall health of the municipal market has greatly improved in recent years, some mu-nicipal issuers are not performing as well in the current environment. This is due to isolated instances where state or local governments are having difficulty balancing their budgets, are dealing with under-funded pension obligations or are facing other issues.

Sovereign bonds are debt secu-rities issued by a national govern-ment, most often referencing coun-tries outside of the US. Germany, Australia and Canada are examples of countries with a AAA rating, the

highest level of creditworthiness. The US was downgraded from AAA by Standard and Poor’s in 2011, but remains AAA rated by the other ma-jor rating agencies. These countries tend to have wealthy, diversified and adaptable economies, which supports their capacity to repay debt.

Countries with lower ratings in-clude Brazil, Argentina and Greece, all of which have struggled to meet their financial commitments. Given significant differences in creditwor-thiness, the risk and return associat-ed with sovereign debt varies great-ly. Therefore, investors should do their homework before investing.

Corporate bonds are issued and backed by companies. The ratings of corporate bonds are assigned based on the company’s financial condition and trends. Much like sov-ereign debt, the range of creditwor-thiness among corporate borrowers

is wide. Therefore, investments in this category run the gamut from very safe to speculative.

The majority of the corporate bond market is publicly traded and liquid. However, direct lending has become an increasingly popular strategy among private fund man-agers, involving lending directly to borrowers who cannot access bank loans.

Finally, asset-backed securities (ABS) are bonds collateralised by a pool of assets such as student loans, automobile loans, home equity loans or credit card receivables. ABS are similar to mortgage-backed se-curities, which are popular among some hedge fund managers. These assets are pooled and securitised, freeing capital for the loan origina-tor while allowing investors to di-versify and access a unique stream of income. These investments have the potential to provide higher re-turns than traditional fixed-income offerings.

Q What is the difference between fixed income and equity?

A Generally, fixed-income securi-ties provide a steady stream of

income versus equity, which may or may not offer dividends. Typically, dividend yields are lower than in-terest payments for a given issuer. Fixed income, in theory, has lower risk because debt has a preferential position over equity in a liquidation.

Some fixed-income securities may have a convertible feature that brings them closer to equity. A con-vertible bond can be converted to

Fixed-income investing in 2020Sal Shah and Je� Layman of BKD outline �xed-income

investment strategies being used in recent times

Jeff LaymanBKD

Je� Layman has worked in investment management since 1987. As chief invest-ment o�cer and chair of the BKD Wealth Advisors Investment Committee, he develops and oversees the �rm’s investment process, including asset allocation strategies and investment selection for a�uent families and institutions. He is a Chartered Financial Analyst (CFA) charterholder. The CFA charter is obtained by successfully completing a three-year programme with studies in equity analysis, �xed-income analysis, portfolio management, accounting, economics, derivatives and ethics.

Sal ShahBKD Sal ShahBKD

Sal Shah is an audit partner with more than 25 years of experience serving a full spectrum of investment management entities, including hedge funds, private equity funds, venture capital funds, mutual funds, fund of funds, collateral debt obligation funds, foreign currency, structured products, mortgage-backed assets trading and securitisation companies. He has served alternative investment clients ranging from start-ups to $25bn in asset under management. Shah can be reached on 646-253-5193 or at kshah@bkd.com.

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equity based on the terms of the is-suance. For some investors, this may be a preferred way of investing in a company. Owning a fixed-income in-vestment with the option to convert as the company’s performance im-proves may be a more conservative way to access the potential upside associated with equity ownership. This approach could be more suita-ble for investors who aren’t comfort-able with the long-term and volatile nature of pure equity investing.

Tax treatment differs between the two types of investments. While both interest and dividends are con-sidered income, qualified dividends are currently taxed at a more fa-vourable rate.

For high-income investors, munic-ipal bonds are often preferred due to exemption from federal (and in some cases, state) income tax. The change in market value of either instrument is reflected as unrealised gain or loss

note at 1.52% as of January 31, 2020. Low yields reduce future return potential from bond investments.

• The Federal Reserve indicates it will likely remain on the side-lines in 2020, with no intention to lower rates further. Declin-ing interest rates were a major driver of fixed-income returns in 2019, and this is not likely to repeat.

• Nearly 11 years into this eco-nomic expansion, credit spreads are tight across most sectors. Therefore, the opportunity to earn excess return by diver-sifying across security type is limited.

This article outlines some of the more popular types of fixed-income securities. Fixed income can offer investors more control over their investments, reduce volatility and help in capital preservation. But even in this asset class category, in-vestments run the spectrum from conservative to speculative; there-fore, investors should consider their specific risk appetite before pur-chasing fixed-income securities.

as of the statement date. While fixed income can offer bet-

ter returns than short-term invest-ments such as cash or money mar-ket funds, investors should consider liquidity needs and risk appetite be-fore deciding what types of invest-ments make the most sense.

Q What is the outlook for fixed-income investing in 2020?

A As recently as a year ago, the Federal Reserve was expected

to continue the rate-hike cycle that began in 2015. But the Federal Re-serve changed course in 2019 and instead lowered rates three times. The decline in interest rates sparked a rally in stocks, bonds and other assets. The prices of fixed-income securities rose as interest rates fell.

As a result, bond returns were well above average, with the Barclays Aggregate index gaining 8.72% and the Barclays Municipal index gaining 7.54% for the year.

In 2020, the environment is likely to be significantly different. Several factors should cause more muted returns in the fixed-income markets:

• Current rates are near all-time lows, with the 10-year Treasury

Fixed income provides a steady stream of income flow versus equity, which may or may not pay dividends

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