Fixed income is an asset class that is often misunderstood by investors.

In fact, a 2019 survey conducted by a U.S. investment firm found only 8% of investors were able to accurately define the asset class1, while 44% said they don’t buy bonds because they don’t understand them.

However, fixed income is an essential asset class for most investors, given its potential to smooth out portfolio volatility and perform well when growth assets, such as equities and property markets, are falling. So, to get you started, here we outline the basics that you need to know.

What is fixed income?

Fixed income is a broad asset class which encompasses cash, term deposits and bonds. While not technically within the fixed income category, this article will also cover hybrid securities which are a popular way to access an income stream.

There are various types of bonds you can invest in, including:

  • Government bonds: These are issued by governments and are typically the lowest risk bonds available. The government secures the funds it needs, and in return, the investor receives interest payments at a pre-determined rate.
  • Semi-government bonds: These are much like government bonds, except they are issued by various state and territory governments. Like other bonds, these semi-government bonds come in a variety of maturities and pay different rates of regular interest.
  • Corporate bonds: A corporate bond is issued by a company as opposed to a government.

All bonds are rated and reviewed for creditworthiness by a number of ratings agencies, such as Standard & Poor’s (S&P). Each has its own ranking system, but the highest-rated bonds are commonly referred to as ‘Triple-A’ bonds and the lowest-rated bonds are ranked ‘D’ for companies in default.

The S&P ranking system is detailed below. Note that BBB and above is considered ‘investment grade’. BB and below is considered ‘junk’.

Rating CodeSummarised Definition
AAAThe Borrower’s capacity to meet its financial commitments on the obligation is extremely strong.
AAThe Borrower’s capacity to meet its financial commitments on the obligation is very strong.
AThe Borrower is somewhat more susceptible to the adverse effects of changes in economic conditions, however the capacity to meet its financial commitments is still strong.
BBBAdverse economic conditions are more likely to weaken the borrower’s capacity to meet its financial commitments on the obligation.
BBThe Borrower faces major ongoing uncertainties that could lead to the Borrower’s inadequate capacity to meet its financial commitments on the obligation.
BAdverse business, financial, or economic conditions will likely impair the Borrower’s capacity or willingness to meet its financial commitments on the obligation.
CCCIn the event of adverse business, financial, or economic conditions, the Borrower is not likely to have the capacity to meet its financial commitments on the obligation.
CCThe 'CC' rating is used when a default has not yet occurred, but S&P Global Ratings expects default to be a virtual certainty.
CA Borrower rated 'C' is currently highly vulnerable to nonpayment.
DA Borrower rated 'D' is in default.


How do bonds work?

A bond is simply a loan that you make to an entity, such as a government, or a company.

You receive interest payments, known as a coupon, for the length of the loan and how often you get paid depends on the terms of the bond. The interest rate is typically higher with long-term bonds, given uncertainty increases the longer into future the maturity date is.

When the bond reaches the date of maturity, the issuer (or borrower) repays the principal, or original amount of the loan. As an example, this is how a four-year bond (which pays a 2% yield) would play out.

Day 1 Year 1 Year 2 Year 3 Year 4
Invest $100Receive $2.00Receive $2.00Receive $2.00Receive $2.00
Receive $100

Like stocks, bonds can be traded. When a bond sells at a price lower than the face value, it’s said to be selling at a discount. If sold at a price higher than the face value, it is selling at a premium.

When you purchase a bond there are two sources of returns:

  • Interest from the coupon (interest) payments
  • An increase in the bond price

An increase in price occurs when interest rates go down after you have purchased the bond. Bonds have an inverse relationship to interest rates, so generally when interest rates are rising, bonds prices fall, while falling interest rates usually lead to an increase in bond prices.

Bond YieldsBond PricesExplanation of Bond Returns
Falling Interest Rates

As interest rates fall, the interest payment on existing bonds becomes more attractive to new investors so the bond price rises to reflect the lower interest rate for the new buyer
Rising Interest Rates

As interest rates rise, the interest payment on existing bonds becomes less attractive to new investors so the bond price falls to reflect the higher interest rate for the new buyer

If governments are lowering official interest rates, then it is usually in an effort to stimulate the economy. If this is the case, it is likely share prices have performed poorly during the tougher economic conditions.

As a result, bonds can be considered a defensive investment as they have the potential to go up when the broader economy, and stock markets, are going down. The below chart shows that investment grade bonds have typically performed well when the stock market falls.

IAF is the ASX stock code for an Exchange Traded Fund or ETF that holds a basket of about 510 different bonds.


As another example, the Australian share market fell 23.1% in Q1 2020 during the onset of the COVID-19 pandemic. A professionally managed ‘balanced’ investment portfolio (50% allocation to bonds and 50% allocation to stocks) only fell 7.9%. The bonds in the portfolio not only provided income, but also provided a cushion when the share market fell.

How you can invest in fixed income?

Investing in a single bond can be difficult for individual investors. Not only can individual bonds be hard to buy and sell, but transaction costs can be excessive and poor market transparency can make selecting the right investment difficult.

Instead, it is often better to invest in a diversified portfolio of bonds to spread risk and provide access to different sources of return. One way to do this is via a bond ETF.

A bond ETF invests in a basket of bonds that tracks an underlying index. The index may include government, semi-government or corporate bonds. Bond ETFs trade on an exchange, meaning they can be bought and sold at any time during market hours.

This means you can gain access to hundreds, or even thousands, of bonds at a reasonable price, with the ability to add to your defensive allocation or sell down your allocation to bonds when you want to.

The most popular Australian bond ETF listed on the ASX is:

MarketASX CodeDescription
Australian Fixed IncomeIAFiShares Core Composite Bond ETF: aims to track the performance of the Australian bond market with 510 investment grade fixed income securities issued by the Australian Government, Australian local governments and corporations.

IAF pays quarterly distributions and the management fee is 0.15%. And if ETF investors need to access their investments, they simply sell on the ASX and receive the money two days after placing the trade (T+2).

Building out our fixed income education, ETFs can also be used to invest in cash. Cash ETFs can be useful for times when you choose to reduce your market exposure to equites or bonds and ‘park’ some money safely, to reduce portfolio volatility and await future buying opportunities. Cash ETFs can often offer a greater return than term deposits or savings accounts.

The most popular cash ETF listed on the ASX is:

MarketASX CodeDescription
High Interest CashAAABetaShares Australian High Interest Cash ETF Fund aims to provide exposure to Australian cash deposits that exceed the 30 Day Bank Bill Swap Rate

AAA pays monthly distributions and the management fee is 0.18%. Again, investors can access their money T+2.

While no investment is completely safe, AAA tracks a diversified deposit portfolio. Cash ETFs can offer a higher return than term deposits or the average Australians saving account.

Another popular way to source income is via securities called Hybrids. A ‘Hybrid security’ is a generic term used to describe a security that combines elements of debt securities and equity securities.

Hybrids often pay an interest rate higher than bonds, making them attractive to income-seeking investors.

Hybrids are issued by companies such as the Commonwealth Bank and the characteristics of each hybrid is different, which can make the analysis and selection process quite time consuming. Using an ETF to access hybrids mitigates the risk of being exposed to any single company or hybrid structure.

A popular way to access hybrid securities in a diversified way is via an ETF called HBRD.

MarketASX CodeDescription
Hybrid SecuritiesHBRDBetaShares Active Australian Hybrids ETF aims to provide investors with income returns from an actively managed, diversified portfolio of 37 hybrid securities

HBRD pays monthly distributions and the management fee is 0.55%. The management fee is higher because HBRD is actively managed by an investment professional who selects the hybrids and continually looks for opportunities to increase returns through active trading. Again, investors can access their money through their trading account on a T+2 basis.

Past performance is no indication of future performance. However, to give you an idea of the difference in returns these differing income exposures provide investors, the historical 12-month distribution yield on 26th June 2020 was:

Investment12-month historical distribution yield

To calculate the historical distribution yield, simply add the last 12 months of distributions together then divide by the last traded price.


When deciding how much of your portfolio to invest in fixed income assets, a popular rule of thumb is to consider your age and investment timeframe. For example, if you are 30 with a good 35 years to go until retirement, around 30% of your portfolio might be invested in fixed income. However, a 50-year-old who is much closer to retirement and is more focused on capital preservation may wish to consider a higher fixed income allocation of around 50%.

In addition to the potential for capital appreciation, fixed income investments provide a regular stream of income for your portfolio.

Fixed income investments perform well at different times to growth assets such as equities and property, so they can provide a much smoother ride by helping you to balance out sources of risk and return in your investment portfolio.


Top three take outs

While commonly misunderstood, fixed income is an important asset class which offers significant benefits to an investment portfolio

An ETF, which offers exposure to a basket of bonds or hybrids, is a simple, effective and liquid way to add fixed income to your portfolio

A simple way to consider the appropriate allocation to fixed income can be based on your age and time horizon


  1. BNY Mellon Investment Management, 2019


Important Disclaimer- This information is for educational purposes only and is of a general nature. It has been prepared without consideration of your specific financial situation, particular needs and investment objectives. This information does not constitute financial advice and you should consider your own financial circumstances in assessing the appropriateness of this information.