What You Are Actually Investing in a Fixed Income Fund.

Fixed income fund is touted as the safest asset class in unit trust investment. However, is it as safe as fixed deposit?

NO.

Fixed income funds invest in government and corporate bonds. I previously wrote about bond and how bond prices affect you bond fund NAV as it fluctuates according to business cycle. This is systematic risk, which is inherent to the entire market. You cannot control this but the good thing is, it is somewhat predictable to certain extent. You just know that a recession is looming in the horizon by looking at the various economic indicators.

How NOT to Lose Money in Unit Trust (a case study)

I am not a close follower of the unit trust industry in Malaysia. But if you are, you should have read that RHB Islamic Bond fund NAV plunged overnight 8.323% on 24 October 2011.

News here at FundSupermart

The reason?
Total write down of Tracoma bonds held by the fund portfolio. The value is RM 4.52 million
In layman terms, that means Tracoma defaults on its bond; on its obligation to pay bond holders.Its bond market value drops to ZERO.

Fixed Income Fund NAV determinant: Simplified

Assume last year inflation rate is at 3%. You bought a 6% coupon bond with $ 10,000 which repays you in 2 years. So your real net return was (6-3) = 3% annually. 


This year, inflation rate goes up to 6%. . No one wants to buy the same bond you have now for $ 10,000 because the real net return is 0%. 

What is bond?

Bond is a fixed income securities. If issued by private sector, it is known as corporate bond whereas government bond is also known as Malaysia Government Securities (MGS). It is considered a debt instruments to raise capital to finance expenditure or working capital, without diluting the ownership rights (unlike shares).

Bonds are usually risk free investment, especially for government bonds unless you are living in nation like Greece where government could default on its debt. From investor perspective, they will lend an amount of money to the bond issuer, and in return they will get a predetermined rate of return (coupon payment, usually within 5 to 10 percent) from their capital annually/semi-annually/quarterly. In addition to this, the capital will be repaid to the investor when the bond 'matures', normally within 1 year for short-term bond (aka Treasury Bills) and 10 years for long-term bond (MGS) . This final capital repayment actually be more or less than the initial capital invested, the former known as discount bond and the latter as premium bond. In short, investor is guaranteed to be compensated in periodical coupon payment in addition to the value of discount of the bond 'price'.