Fixed income ETFs aren't just great for portfolio diversification - find out how they also produce value through income distributions and capital gains!
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What do fixed income investors and chicken farmers have in common?
They both know how to turn their assets into a steady stream of income!
…stay with us here!
A chicken farmer doesn’t rely on selling the farm itself to make money… they rely on the eggs it produces - day in, day out.
In a similar way, fixed income investors aren’t chasing big, unpredictable gains… they’re focused on generating regular, reliable income from the assets they hold.
In short, fixed income ETFs give you access to a diversified mix of bonds that are designed to pay consistent income over time. So instead of relying purely on growth… you’re building a portfolio that can actually pay you along the way.
Let’s break it down.
Need a refresher on fixed income? Here’s some useful pre-reading:
Fixed income ETFs are essentially a bundle of different bonds, including investment-grade corporate bonds, government bonds and securitised debt. Bonds are basically IOUs where governments and companies borrow money from investors in exchange for regular interest payments (known as coupons).
The nature of bonds (as opposed to shares) means fixed income investors benefit from a much more steady and predictable flow of income compared to equity investors.
BUT fixed income ≠ fixed distribution
While you might be tempted to think that fixed income ETFs will pay you the same distribution over time, this is usually not the case.
A fixed income ETF can hold hundreds of bonds that mature at different times and may be replaced with a bond that pays more or less interest…leading to some differences in each distribution.
Let’s go back to the chicken example. A farmer has 3 chickens that lay 5 eggs a week, but then one chicken gets sick and is replaced with a newer chicken that only lays 4 eggs a week. The farmer still gets their eggs, just a different amount.
Fixed income ETFs are kinda the same. They reward investors with a regular income stream, but the amount may vary a little over time.
For a farmer, a chicken isn’t just valuable because it produces eggs. The chicken itself is valuable and can be sold to other farmers.
Depending on the market conditions at the time of sale, it might be possible to sell the chicken for more than its cost price…leading to a capital gain, on top of the regular stream of egg income.
Similarly, the value of a fixed income ETF can also fluctuate when market conditions change.
To understand this better, let's zoom into an individual bond.
When the company or government first sells its bond, the transaction happens on the primary market for a set price (called face value). Afterwards, investors can buy and sell existing bonds on the secondary market, and this is where price movements happen.
The price of a bond is mainly determined by interest rates, credit quality (how reliable the bond issuer is), the bond’s term to maturity and the current supply and demand for bonds.
So investors can make a profit when the current value of its bond increases beyond its face value.
Luckily fixed income ETF investors don’t have to worry about the price changes of each individual bond. Instead, fixed income ETFs trade on the share market (like the ASX) just like ordinary shares.
This means the ETF itself may go up in value over time and can produce a capital gain for investors that sell their units at a higher price than what they paid at the time of purchase.
Fixed income ETF investors reap the benefits of asset diversification, along with the ease and liquidity that comes with owning shares.
So whether your goals are income, diversification or total returns, Franklin Templeton’s range of fixed income strategies can play a role as part of a diversified portfolio.
Find out more about Franklin Templeton’s fixed income capabilities
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