Fixed income is lending. You buy a bond and become a creditor, entitled to a stream of interest payments and the return of your principal at maturity. In exchange for giving up the upside of ownership, you get a contracted, senior claim that pays whether or not the borrower prospers, as long as it does not default. It is the ballast of most portfolios and the reference point against which every other asset is priced.
The asset class runs from the safest thing in finance, short-dated government debt, to the riskiest, distressed high-yield bonds trading at cents on the dollar. Understanding fixed income means understanding two forces above all others: interest rates and credit risk.
Interest rate risk and duration
A bond's price moves opposite to interest rates: when rates rise, existing bonds paying the old, lower coupon become worth less, and vice versa. Duration measures how sharply a bond reacts, longer-dated bonds swing far more than short ones. This single relationship explains most of what happens to bond portfolios, and why a "safe" long bond can lose heavily when rates jump.
Allocators use duration deliberately. A pension matching long liabilities wants long duration. An investor worried about rising rates shortens it. The choice is not incidental, it is often the biggest active bet in a bond portfolio.
Credit risk and the spread
Beyond government debt, bonds carry credit risk: the chance the borrower fails to pay. Investors demand a spread, extra yield over the risk-free rate, to bear it. Investment-grade bonds pay a modest spread, high-yield or "junk" bonds pay a large one, and the size of that spread is the market's live verdict on default risk.
The job in credit is to be paid more in spread than you lose to defaults over time. Widening spreads punish existing holders but reward new buyers, which is why credit tends to offer its best returns precisely when it feels most dangerous to buy.
What it does in a portfolio
Fixed income plays three roles: it generates predictable income, it preserves capital in high-quality form, and, historically, it diversifies equities by rising when stocks fall. That last property, the negative correlation in a crisis, is what makes government bonds the classic hedge, though it weakens when inflation, rather than growth, is the shock.
The allocator's task is to decide which of those three jobs a bond allocation is really for. Income, safety and diversification pull toward different bonds, and confusing them, reaching for yield while expecting safety, is the recurring mistake in fixed income.
Who plays this
Insurance companies are the natural owners of long fixed income, matching bond duration against long-dated policy liabilities, and are among the largest holders of investment-grade credit. Pension funds hold bonds for the same liability-matching reason. Asset managers run the bond funds and ETFs most allocators actually buy, while hedge funds trade the volatile, relative-value corners of the market, government bond spreads, distressed credit, that need active management to exploit.
See the Buyside Firms track for how insurers and pensions size and manage these liability-driven books.