Fixed Income Investing

Why Invest in Fixed Income Key Points:

Fixed income securities (bonds) are a fundamental part of an investing plan for  Why Invest in Fixed Income?
most investors. There are many types of bonds along with varied approaches to
 Risks Involved in Fixed Income Investing
fixed income investing, each with their own advantages and levels of risk. Although
stocks have historically outperformed bonds over the long term, there are a number  How to Invest in Fixed Income
of reasons to include fixed income investments in a diversified portfolio, including:
 The Benefits of Active Fixed
Income Income Management
Fixed income generally offers higher yields than equities or other securities as
well as regular coupon payments, providing bond owners a potentially attractive,
regular income stream.

Capital Preservation
Some investors may not want to take a significant amount of risk with their portfolios.
Bond prices, especially those of high-quality bonds, tend to be less volatile than
other securities, typically offering investors a lower risk profile.

Diversification
Fixed income securities have historically demonstrated a low correlation to equities
(see below), meaning there is little relationship between how the two asset classes
have performed over a given time. Therefore, owning fixed income securities along
with equities adds a potential risk-reducing effect to an investor’s portfolio.

Correlation Table (January 1998-December 2008)

US Municipal Corporate Large-Cap Small-Cap International
TIPS Commodities
Bonds Bonds Bonds US Stocks US Stocks Stocks

US Bonds 1.00 0.73 0.88 0.79 -0.10 -0.09 -0.03 0.02

Municipal
1.00 0.70 0.61 -0.02 0.00 0.03 0.03
Bonds
Corporate 0.14
1.00 0.77 0.16 0.17 0.25
Bonds

TIPS 1.00 0.00 0.00 0.10 0.27

Large-Cap 0.16
1.00 0.78 0.84
US Stocks
Small-Cap
1.00 0.75 0.22
US Stocks
International
1.00 0.29
Stocks

Commodities 1.00

Source: Lipper; Bloomberg. Past correlations are no guarantee of future results. Correlation ranges from -1 to 1, with -1 indicating that the returns move perfectly opposite to one another, 0 indicating no relationship and 1
indicating that the asset classes react exactly the same. This is for illustrative purposes only and not indicative of any investment. US bonds in this example are represented by the Barclays Capital US Aggregate Index,
Municipal bonds by the Barclays Capital Municipal Bond Index, corporate bonds by the Barclays Capital US Corporate Investment Grade Index, inflation protected Treasuries by the Barclays Capital US Tips Index, large-cap
US stocks by the Standard & Poor’s 500 Index, small-cap US stocks by the Russell 2000 Index, international stocks by the Morgan Stanley Capital International Europe, Far East, Australasia Index, and commodities by the
S&P GSCI Index. An investment cannot be made directly in an index.

NOT FDIC INSURED I MAY LOSE VALUE I NO BANK GUARANTEE

Spreading Market Exposure
High-quality bonds have historically performed well when other asset classes
struggle. A low correlation to stocks generally makes bond owners less vulnerable
to shocks in the equities markets. For instance, in the late 1990s, with the Internet
and telecommunications bubbles at their peak, some investors questioned the need
to invest in anything outside of equities. But when those bubbles burst shortly
thereafter, fixed income securities held up much better than equities.

The chart below shows year-by-year performance of three hypothetical portfolios:

an all-equity portfolio, a balanced portfolio consisting of 60% equities and 40% fixed
income and a third consisting solely of fixed income securities. The chart shows
that, in three periods of stock market distress, a 100% bond portfolio held up far
better than an all-stock portfolio, and the 60/40 blend also fared better than the
all-stock portfolio.

Amid Stock Declines, Bonds Have Persevered

40
35
30
25
20
15
% Annual Return

10
5
0
-5
-10
-15
Credit Crisis
-20
-25
-30
Iraq invades Kuwait Technology
-35
stocks falter
-40
‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08
100% Fixed Income
100% Equity
60% Equity / 40% Fixed Income

As of 12/31/08.
Source: Lipper. Past performance is no guarantee of future results. All returns assume reinvestment of all distributions. All-equity portfolio
reflects the returns of a hypothetical investment in the S&P 500 Index, the balanced portfolio represents returns of a hypothetical investment in
a portfolio made up of 60% of the S&P 500 Index and 40% of the Barclays Capital US Aggregate Index and the fixed income portfolio represents
a hypothetical investment in the Barclays Capital US Aggregate Index. It is not possible to invest directly in an index.

Risks Involved in Fixed Income Investing

Investing in fixed income securities entails specific kinds of risks. Interest rate
risk affects all fixed income investing, and credit and cash flow risk relate more
to specific individual investments.

Interest Rate Risk

A broad risk associated with buying and holding fixed income investments is interest
rate risk — the possibility that the relative value of a bond will decline due to an
interest rate increase. In general, as rates rise, the price of a bond will fall, and
vice versa.

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Credit Risk
This includes default risk, which is the risk that a bond issuer, usually due to
financial hardship, will be unable to fully repay the loan represented by the bond.

If an issuer is expected to have difficulty in meeting its payment obligations, its

credit rating could be lowered, negatively affecting its value. This is known as
credit quality risk.

Individual bonds are also prone to event risk—the possibility that a business, economic
or political event will negatively impact the value of the investment. Event risk is
largely a concern in corporate bonds, which are bonds issued by companies.

US Treasury securities—such as bills, notes and bonds—are debt obligations of

the US government that are backed by the “full faith and credit” of the government
and, therefore, are not subject to credit risk.

Cash Flow Risk

Though bonds have a stated maturity, some can be called away by an issuer ahead
of its maturity date. Some fixed income securities, such as mortgage-backed
securities, have embedded call options which may be exercised by the mortgage
holder. The risk associated with the early return of principal on a fixed income
security is called prepayment risk. In contrast, extension risk is the possibility of a
security lengthening in duration due to the deceleration of prepayments. Both can
diminish a bond’s total return and alter its risk/return characteristics.

To help minimize cash flow risk, direct bondholders generally buy high-quality
securities without embedded call options. While this does offset some risk,
holding high-quality securities can cause investors to forfeit potentially higher
investment returns.

How to Invest in Fixed Income

There are a number of ways for investors to gain access to fixed income assets,
including by purchasing individual bonds, constructing a “ladder” of individual
bonds, buying index products or owning shares in actively managed portfolios,
such as fixed income mutual funds.

Because investors have diverse investment goals, there is no “one size fits all”
approach to owning bonds. However, active portfolio management, led by an
investment team and driven by professional analysis, can provide a solid foundation
to the fixed income portion of many investors’ portfolios.

Buying Individual Bonds

Fixed income securities, or bonds, are debt obligations of the issuer, such as a
government, municipality, corporation, federal agency or other entity. In return
for the proceeds raised from issuing the bonds, the issuer is obligated to pay interest
to the bondholders. Bonds pay interest that can be fixed, floating or payable at
maturity to the bondholder. Most fixed income securities carry an interest rate
that stays fixed until maturity at a percentage of the face (principal) amount. Typically,
investors receive interest payments monthly, quarterly or semiannually, depending
upon the nature and the maturity of the bond. For example, a $1,000 bond with
an 8% interest rate that pays interest semiannually will pay investors $80 a year,
in payments of $40 every six months. When the bond matures, investors receive
the full face amount of the bond—$1,000.

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Investors often turn to fixed income securities when seeking a steady source of Typical Ladder Structure
income, greater portfolio diversification or to preserve wealth. Some investors own
individual bonds directly, often selecting them with the help of a financial professional. With $50,000 to invest in bonds, an investor
This offers transparency — investors know exactly what they hold — and makes could purchase five different bonds each
clear a bond’s maturity date and specific level of interest income. with a face value of $10,000, with each
Laddering Individual Bonds maturing on a different date. One bond
Another way to own bonds directly is to construct a bond “ladder.” In this structure,
might mature in one year, another in three
an investor holds a variety of bonds with staggered maturity dates so that a portion
of the portfolio will mature each year. To maintain the ladder, money that comes in years and the remaining bonds might mature
from maturing bonds is reinvested in bonds with longer maturities within the range in five-plus years, each representing a
of the ladder. This regular reinvestment in bonds at prices (and therefore yields) different rung on the ladder. Staggering the
current at the time of reinvestment helps to reduce exposure to interest rate risk
maturity dates leaves a bond portfolio less
and helps to protect against inflation.
exposed to interest rate fluctuations.
Up and Down the Ladder
Ladder investors take comfort in the fact that, should rates rise after they have
Maturities
bought some bonds, money will soon come available to buy higher-yielding bonds.
20% 10-Year
Similarly, if rates decline, a ladder investor has locked in the higher rates in the
ladder’s more mature holdings.
20% 7-Year
Where Ladders Fall Short
Difficult to Manage
20% 5-Year
Most individual investors do not have the experience or skills to manage a large,
diversified ladder of individual bonds, many of which trade at prices of $1,000
or more. 20% 2-Year

Provide Insufficient Diversification

Ladder investors typically purchase and create ladders using high-quality vanilla 20% 3-Month
bonds (e.g., US Treasuries and investment-grade corporates) as this provides them
relatively more certainty (i.e., lower risk) with regard to coupon flow and return of
principal at maturity. The trade-off for this certainty or lower risk is missing out
on the potentially higher returns than can be achieved through investing in other
types of bonds, such as high yield and emerging market debt as well as some
securitized assets, e.g., asset-backed securities (ABS), mortgage-backed securities
(MBS) and commercial mortgage-backed securities (CMBS). Ladder investors are
also generally biased toward short and intermediate maturities rather than
long-term bond issues which typically offer higher yields.

Difficult to Measure Relative Performance

It is difficult to construct a benchmark to measure the performance of an investor’s
ladder strategy. Ladder investors therefore have virtually no way of gauging whether
their returns are better, worse or the same as a comparable market bellwether.

Liquidity Constraints
Accessing funds invested in a ladder is difficult. If they need money, ladder investors
either have to sell a bond prematurely or not reinvest funds received from a maturing
bond. Either of these options can not only undermine a ladder strategy, but also
possibly reduce the income it can generate.

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Missed Opportunities Simplifying Bond Investing
Ladder investors may be unable to buy or sell bonds at opportune times, i.e.,
when prices are considered very low (buy) or very high (sell), as they are locked Active management places the responsibility
into buying and selling at specific times. of selecting bonds on a team of professionals,

Unable to Reinvest Coupons armed with sophisticated research capa-

Bond ladder investors are typically unable to reinvest coupon proceeds, which bilities and advantages in executing trades.
denies them the benefits of earning compound interest.
Actively managed portfolios offer broader
exposure to the fixed income market than
The Benefits of Active Fixed Income Management
buying bonds directly, enhancing portfolio
Bond Mutual Funds
With active portfolio management, a portfolio manager and team of research analysts diversification and return potential. As a
select securities in an attempt to offer shareholders index beating returns along practical matter, hiring an active fixed income
with prudent levels of risk. There are several strategies unique to active portfolio
manager frees both the individual investor
managers and unavailable to more passive forms of investing.
and financial professional from the compli-
The three general areas where active management delivers value are: greater access
cation of regular fixed income analysis,
to markets, fundamental analysis and advantages in the execution of trades on
behalf of investors. and instead makes bond investing a

Access simple component of a broad investment

Because they pool assets of many investors, managed portfolios buy both a larger picture. In addition, actively managed
number and wider variety of fixed income securities than available to most individual portfolios offer low investment minimums
bond buyers. This provides greater diversification —a strategy of owning dissimilar
and automatic reinvestment of distributions
securities to help lower overall portfolio risk.
along with simplicity in monitoring invest-
Analysis
ments through annual and semiannual
Active portfolio management channels the collective insight and analysis of a team
of investment professionals and equips the portfolio manager with flexibility to make shareholder reports.
adjustments on behalf of shareholders. While companies generally issue one type
of stock to denote equity ownership, a company or other entity may issue a variety
of types of bonds. This greater choice can complicate selecting which individual
bonds to purchase. Portfolio managers have the expertise to pick and choose among
the range of fixed income securities that they believe have the best potential, and
can dedicate the time and resources needed to monitor portfolio holdings to determine
if better opportunities exist elsewhere.

Central functions of active fixed income management include performing credit

research, undertaking detailed analysis, forecasting creditworthiness of individual
securities and following larger fixed income trends. These can help minimize risk
and exploit market opportunities, abilities largely absent from the laddering approach.
In addition, active investment managers conduct sector and sub-sector analysis to
determine which parts of the fixed income markets appear attractive enough to
emphasize in the portfolio.

Active portfolio management is more nimble than laddering. To combat interest

rate risk, portfolio managers may adjust the duration of a portfolio if their research
supports it. For example, a manager may lengthen the portfolio’s duration if the
portfolio manager is of the opinion that interest rates are likely to fall. Duration
measures the sensitivity of a bond’s price to interest rate movements. However,
similar to a laddering strategy, bond funds are able to buy new bonds paying higher
interest, which will increase income payments over time.

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Execution About BlackRock
Investment institutions that run managed bond portfolios have relationships with
BlackRock is one of the world’s preeminent
large bond dealers and regional specialists that typically enable them to buy bonds
asset management firms and a premier
at lower prices than those available to retail clients. The advantages of speed and
provider of global investment management,
size when making trades help investment institutions keep costs in check, delivering
risk management and advisory services to
value to the investor.
institutional, intermediary and individual
investors around the world. BlackRock offers
Bond Mutual Fund Risks a wide range of investment strategies and
There are no guarantees when investing in a bond mutual fund. Bond funds continually product structures to meet clients’ needs.
buy and sell their shares to the public at the fund’s daily determined net asset value These include individual and institutional
(NAV). A bond fund’s NAV will fluctuate based on the value of its holdings and current separate accounts, mutual funds and other
market conditions, especially the current level of interest rates. There is no maturity pooled investment vehicles, and the industry-
date that a bond fund can provide as a deadline for returning the full amount of leading iShares® ETFs.
your investment. In addition, it is not possible to determine an expected yield to
Through BlackRock Solutions®, we offer
maturity for a bond fund as you can with individual bonds. With a bond fund, you
risk management, strategic advisory and
receive whatever the bond shares are worth at the time you redeem shares from the
enterprise investment system services to
fund. It is therefore possible to sustain a capital loss from investing in a bond fund.
a broad base of clients. The firm employs
Even if the individual bonds in the fund are guaranteed by the government or insured more than 8,500 talented professionals in
through a private insurer, the value of a bond mutual fund investment can still rise 24 countries around the world. For additional
or fall. Bond mutual funds are not insured or guaranteed by the Federal Deposit information, please visit the firm’s website
Insurance Corporation (FDIC), the US Securities Investor Protection Corporation at www.blackrock.com.
(SIPC) or by any other government agency, regardless of how a bond mutual fund
is purchased— through a brokerage firm, a bank, an insurance agency, a financial
planning firm or directly. They are also not guaranteed by the bank, brokerage firm
or other financial institution where they are sold.

Consult your financial professional to help develop the fixed income component
of your overall investment strategy.

This material is provided as an educational tool and is not meant as an investment recommendation. The information contained in this
material is in part derived from third-party sources deemed reliable, but BlackRock does not guarantee the completeness or accuracy
of the information.
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