John Labunski Dallas - Comparison Between Fixed Income and Shares

With the basic interest rate (SELIC) in an upward cycle in Brazil since the beginning of 2021, many investors are reviewing their portfolios of financial assets in order to increase exposure to fixed income. We have also seen that the FED (US Central Bank) will not only start increasing the US basic interest rate, but will also reduce the purchase of assets in order to discourage economic activity there, and thus, contain inflation.

In this scenario, it is worth making a parallel between the two main financial assets available in the financial market and known to most investors, which are fixed income assets and shares.

Fixed income

 As a general rule, any financial investment with a determined term and profitability is classified as fixed income. Examples:

CDB (Bank Deposit Certificate, bank-issued security) maturing on 02/22/2024 and yielding 12.5% ​​pa;

LFT (Treasury Financial Bill or Selic Treasury) maturing on 03/01/2027 and yielding SELIC + 0.15% pa;

Debenture (security issued by a private company) with maturity 09/15/2031 and yield of IPC-A + 7% pa

The three examples above, although they seem different in terms of profitability, are subdivisions of fixed income, respectively, fixed-rate, floating-rate and inflation-linked (which is also floating-rate).

Another important feature of fixed income is that the relationship between the borrowing agent (the one who lends from someone) and the creditor (the one who lends to someone) is based on credit.

That is, given that the maturity (term of the fixed income security) and the profitability are already defined between the parties since the beginning of the relationship (in the purchase of the security), the creditor has no interest in the institution that lent it.

Internationally, there are fixed income securities such as bonds, debentures, treasuries.

In accounting terms, a fixed-income asset, from the borrower's point of view, enters the balance sheet either as a current liability or as a non-current liability, depending on the maturity term and coupons (interim payments, if any).

In terms of risk, the most obvious type of risk is the borrower's credit risk. Since the rate and term are already defined, the risk of non-payment (default) remains. However, also on the balance sheet, liabilities have priority over shareholders' equity.

Actions

According to the definition of fixed income, it is easy to verify that stocks do not have the two fundamental characteristics of fixed income (determined term and profitability). Therefore, the shares belong to the variable income classification.

Going a little further, a share is the smallest share of a company's society. Thus, the fact that an investor owns shares in a company constitutes a direct involvement with the business of that company. For this reason, the relationship with this type of investment becomes even stronger, since the owner of the share is listed in the company's equity. This relationship is also known as equity.

In the case of stocks, the risk that stands out is market risk, since stocks have high liquidity, price fluctuations can be quite expressive in one day, both higher and lower.

Primary and Secondary Markets

It is important to be clear that there are two types of markets for both of the above-mentioned securities, namely:

Primary Market: consists of the issuance of securities, whether fixed income or shares. As expected, naturally these are events that occur in a specific way. It consists of the essence of the capital market, that is, the intermediation between the investor (surplus agent) and the borrower (deficit agent). In other words, it is when the fundraising from the investor to the borrower actually takes place.

Secondary Market: once the asset has been issued, it is allowed to “change hands” between investors, and as in the primary market, it can be fixed income or a stock.

The secondary stock market is much more dynamic and more common to investors. The stock exchange is the environment that allows trading to take place at a high frequency, to the point that the same shareholder of the same company can buy and sell a stock several times a day, if he wants to. Or also that a significant part of members is changed several times during the day.

Fixed-income securities, on the other hand, can also be traded on the secondary side, but the frequency of trading, due to the nature of the price fluctuation of these securities, is lower than that of shares. For this reason, the stock exchange is no longer the environment for this. This is where the platforms of securities distributors (DTVM) come in, better known as brokers.

Summing Up

Although they have distinct characteristics, stocks and fixed income are essential assets in a portfolio with good diversification. As we have seen, having these two investments in their portfolio, the investor can combine predictability (in profitability and term) with high returns, have exposure to different types of risks, add or reduce liquidity in the portfolio.