Advisers need to recalibrate for missing income
Equity markets have become particularly narrow and volatile, with a small group of global mega-cap stocks accounting for a significant share of returns. Recent market movements have highlighted correlations amongst asset classes rise in periods of stress, but more surprisingly for most investors, movements in traditional safe-haven assets like government bonds have not been fulfilling its role as a traditional portfolio hedge against risk.
Consistent with this backdrop, the Reserve Bank of Australia has noted that "compensation for risk remained very low", citing tight credit spreads, low volatility and compressed equity premia, conditions that can tighten quickly should downside risks emerge.
The advisers' challenge in a less diversified market
Australian investors may be particularly exposed to this dynamic. Structural features such as the superannuation system, franking credits and long investment horizons have supported higher equity weightings for many years.
As equities delivered strong outcomes, many portfolios gradually drifted away from fixed income with little friction. Today, that drift leaves portfolios increasingly reliant on a narrow set of market outcomes at a time when diversification is becoming more valuable.
Across the market, there is a renewed focus on seeking income solutions that do not rely on equity markets. The key question is no longer whether to integrate fixed income, but how to construct allocations that genuinely diversify sources of risk.
Understanding the fixed-income spectrum
A common misconception is that fixed income simply means "bonds and cash". In reality, the asset class spans duration, credit and structural risk – distinctions that now matter far more for portfolio construction than they once did.
Australian government bonds remain an important defensive anchor. They can provide diversification when growth expectations weaken or yields fall, though longer duration exposures can experience volatility when interest rate expectations shift quickly.
Investment-grade corporate bonds continue to offer predictable credit exposure and carry in stable environments. However, spreads remain relatively tight compared with historical averages, limiting the additional compensation available for incremental credit risk.
Floating-rate notes (FRNs) reduce duration sensitivity because coupons reset with reference rates, allowing income to adapt as policy settings change. However, they still carry issuer credit and liquidity risks.
Hybrids remain popular within the Australian income universe, though their role in portfolios is often misunderstood. During periods of market stress, hybrids can behave more like equity-linked instruments than defensive fixed income. Regulatory changes, including APRA's transition away from certain AT1 hybrid structures, are also prompting advisers to reassess their role within income allocations.
Why structure matters as much as asset class labels
We are seeing a clear shift toward floating-rate and securitised structures where income is tied more directly to borrower cashflows rather than market direction.
When constructing portfolios, income reliability is only part of the equation. Capital volatility is also a key consideration when building defensive portfolios.
In securitised and private credit strategies, NAV behaviour is primarily driven by the private nature of the assets being invested in. Assets trade within the financial system based on outstanding principal and accrued income, rather than being continuously marked to secondary market prices. This provides stability to investors, as long as the asset quality is robust and structural protections are in place to cover any potential impairments.
As a result, volatility in NAV is rare as long as the portfolio is performing in line with expectations, and the assets have sufficient structural protections which absorb the expected credit losses. The use of floating-rate instruments reduces interest rate sensitivity, as changes in cash rates influence income levels rather than causing immediate changes in NAV from interest rate duration.
This contrasts with traditional fixed income portfolios, where NAVs are reset daily based on market pricing. Even high-quality government and corporate bond funds can experience meaningful short term NAV volatility when yields or spreads move, despite having no deterioration in underlying credit quality.
Structural credit protections, including diversification, loan-to-value buffers, subordination, excess spread and reserve accounts, can further support NAV stability by absorbing stress within the structure before it reaches senior investors. In these strategies, NAV movements are therefore more closely linked to borrower fundamentals over time, rather than to shifts in market sentiment.
Importantly, this does not remove risk. Rather, it reflects a different risk profile, where NAV outcomes are driven by cashflow performance and credit quality, rather than near term market repricing.
Investors are increasingly prioritising resilience, income streams that can adjust to changing rate environments without amplifying duration or correlation risks. This has driven growing interest in floating‑rate and securitised credit structures, where returns are linked more closely to borrower cashflows than to market direction.
Securitised credit can provide one example of how structural design influences portfolio behaviour. However, outcomes can vary significantly depending on collateral quality, underwriting standards and the level of structural protection within the transaction.
When assessing such exposures, advisers should look beyond headline yield and examine the underlying collateral, loan-to-value profiles, verification standards and responsible lending practices. In well‑structured portfolios, borrower equity represents the first layer of loss absorption, meaning property values must decline materially before lender capital is exposed. Additional resilience can be provided through structural protections such as subordination, excess spread, reserve accounts and covenant triggers. These features are designed to absorb stress progressively, allowing cashflows and subordinated capital to act as buffers before losses reach senior investors.
Equally important are servicing capabilities, transparency of reporting and alignment between the issuer and investor. Structures where the manager avoids junior or first‑loss positions can further reduce relative risk by ensuring losses are borne first by subordinated capital held by the originator, reinforcing underwriting discipline and aligning incentives through the credit cycle.
Taken together, these elements help explain why high‑quality securitised credit can deliver floating‑rate income with a capital profile that is less dependent on secondary‑market pricing.
Liquidity considerations in securitised income strategies
While securitised credit is often perceived as less liquid due to the long-dated nature of the underlying loans, liquidity outcomes are heavily influenced by how exposures are structured rather than by asset type alone.
For vanilla simple asset classes such as regulated home loans, larger managers aligned with a non-bank can access the liquidity from warehouse funding on a daily basis, while underlying loans perform as expected. This provides a highly certain solution as it is contracted and funded. These features can allow investor redemptions to be managed independently of secondary market conditions, due to the access to committed warehouse and institutional funding facilities.
More concentrated direct lending and risky property development or corporate lending portfolios, generally do not have the ability to access warehouse funding increasing liquidity risks to investors.
As with all managed investments, withdrawal rights remain subject to market conditions and the fund's governing documents. However, structural liquidity mechanisms reduce reliance on market risk from asset sales and help support more consistent liquidity outcomes over time.
Building genuinely diversified income portfolios
As markets normalise, rebuilding diversification is less about increasing allocations indiscriminately and more about understanding the structural drivers behind each income source. In practice, this often means:
Separating risk drivers.
Combining rate-sensitive defensive anchors such as government bonds with credit and structural exposures whose cashflows are borrower-linked rather than market-directional.
Dialling duration intentionally.
Using government bonds and floating-rate instruments to manage interest-rate sensitivity in line with portfolio objectives.
Being selective with credit.
Prioritising credit quality and structure over raw yield, particularly when spreads remain relatively tight.
Incorporating securitised cashflows thoughtfully.
High-quality securitised credit can provide floating-rate income backed by real assets, borrower repayments, and structural credit enhancement.
Ultimately, diversification is strongest when it is built on different sources of risk, rather than simply different asset labels.
Where this approach may fit
For many investors, including retirees, pre-retirees, SMSFs and diversified multi-asset portfolios, a resilient income allocation may include high-quality securitised credit providing borrower-linked, floating-rate income with structural protections., such as those used in our income strategies including the Real Income Fund and RAM Secured Income Notes (ASX: RAMHA).
Learn more about Real Asset Management Group
For more information on Real Asset Management Group and their funds and strategies visit their website.