How to Talk to Your Clients About Fixed Income
Many investors know that bonds can provide stability and a predictable income stream. However, evaluating return potential, risks, fees, pricing, and the role of fixed income in overall portfolio diversification often requires professional guidance.
Here are key discussion points that can help clients make better-informed portfolio decisions.
Become familiar with the role of bonds in a portfolio
Retail investors, particularly those new to financial markets, often focus primarily on potential returns and therefore tend to prefer equities over other investment options. While bond returns may appear less exciting than equities, there are compelling reasons to allocate part of a portfolio to fixed income.
Explaining how the typical bond return profile can help smooth overall portfolio performance – especially during periods of volatility when stocks may suffer significant losses – highlights the rationale for including fixed income in a diversified investment strategy.
Annual returns by asset class: 1991 - 2023
Source: Bloomberg as of 31 December 2025.
U.S. equities are represented by the S&P 500 Index, global equities are represented by the MSCI EAFE Net Total Return Index, U.S. bonds are represented by the Bloomberg US Aggregate Bond Index, global bonds are represented by the Bloomberg Global-Aggregate Total Return Index and cash is represented by the FTSE three-month Treasury Bill Index. Past performance is not a guarantee of future results. Performance reflects unmanaged index returns and is not representative of past, or predictive of future performance of any PIMCO strategy or investment product. It is not possible to invest directly in an unmanaged index.
Assessing return potential
It can be helpful to explain to clients that equities, even those with strong historical performance, still carry a meaningful degree of uncertainty. Bonds, on the other hand, typically offer greater predictability because their expected returns can be approximated using a bond’s yield-to-maturity (YTM). In general, a higher YTM implies a higher potential return if the bond is held to maturity.
For individual bonds, information such as price, coupon rate, and maturity is easily accessible. As long as an investor doesn’t plan to sell the bond before maturity and the issuer does not default, the YTM (expressed as an annualized percentage) provides a reasonably accurate estimate of the bond’s expected return. This makes YTM a useful measure to compare different bonds.
For fixed income funds, which typically hold multiple bonds with different characteristics, estimating the expected return can be more complicated. The YTM number reported for a fund represents the weighted average yield of all the bonds in the portfolio. As the fund manager may actively buy and sell bonds, the fund’s YTM can change over time. As a result, a fund’s YTM should be viewed as an estimate rather than a precise indicator of future returns.
Understanding pricing and performance
Once a client is familiar with the concept of a bond’s return profile, it’s useful to outline the three main factors influencing bond performance:
- Market conditions: How investors feel about the wider economy (also known as ‘investor sentiment’) has an impact on bond markets. When economic conditions are strong and stocks are rising, investors typically move more capital into equities. In periods of economic uncertainty, they may move capital into bonds, which can increase demand and influence pricing.
- Ratings: Credit ratings assigned by agencies such as Moody’s or Standard & Poor’s reflect their assessment of an issuer’s ability to meet interest and principal payments. If a bond’s credit rating is downgraded, investors may perceive it as riskier and its price will likely fall.
- Age: A bond’s price is also affected by its age relative to its maturity date. As a bond approaches maturity, its price will generally converge towards par value. The diagram below illustrates the effect of time on the price of a bond when the prevailing interest rate is 5%.
The effect of time on bond pricing
Source: PIMCO. For illustrative purposes only.
Assessing risks
Even though high-quality bonds tend to be more stable than other asset classes, there are several risks that clients should be aware of before investing:
Interest rate risk: This is the risk that a bond's price will fall when market interest rates rise. When new bonds are issued at higher yields, the prices of existing bonds with lower coupons typically fall to remain competitive.
Inflation risk: Inflation reduces the purchasing power of a bond’s fixed interest payments. If consumer prices rise more quickly than expected, the “real” value of those payments declines. Central banks often respond to high inflation by raising interest rates, which in turn can put downward pressure on bond prices.
The interest rates on bonds are typically expressed as either:
- A nominal rate, which is the stated rate, not adjusted for inflation; or
- A real interest rate, which is the nominal rate minus the rate of inflation. For example, if a bond has a nominal interest rate of 5% and inflation is 2%, the real interest rate will be 3%.
Credit risk: Every bond carries some risk of default – in other words, that the issuer will fail to pay the coupon and principal payments on time and in full.
Reinvestment risk: If investors choose to reinvest coupon payments or principal into new bonds at a time when interest rates have fallen, they may be forced to purchase new bonds offering lower yields, reducing overall return potential.
Understanding fees
Prospective bond fund investors should be aware of the fees charged by fund managers. The expense ratio is a commonly used measure that reflects the total annual cost of operating the fund, expressed as a percentage of assets under management.
Passive bond funds often have lower expense ratios, which can make them appear more cost‑effective. However, active managers seek to deliver returns that justify their fees by outperforming passive alternatives on a net‑of‑fee basis.
