Why I keep coming back to fixed coupon notes
I like investments that can earn their keep without requiring me to trade constantly. Fixed coupon notes fit that preference, particularly when markets are going sideways or moving within a relatively tight range.
Those aren’t necessarily exciting conditions for someone buying shares and hoping for a rally. For an FCN, they can be perfectly satisfactory. I collect coupons without needing prices to make much progress.
For anyone unfamiliar with them, an FCN pays a fixed coupon while it remains outstanding, but my capital is at risk. Depending on how the investments it tracks perform, I may get my money back or end up receiving the weakest performer at a price above its market value. DBS has a fuller explanation with examples. I’ll leave the diagrams to them.
When I tend to buy
I tend to look at FCNs when markets have taken a moderate dip and volatility has picked up. Higher volatility generally allows for higher coupons, all else being equal, while the lower starting prices may offer a more attractive entry point.
What I’m looking for is a setback that I think markets can recover from, rather than something whose investment case has fundamentally changed. That is a judgment call, of course. A moderate dip doesn’t come with confirmation that it has finished dipping.
If markets subsequently settle into a range, the note can continue paying its coupons. If they recover enough to trigger early repayment, I get my capital back and decide what to do next. I won’t capture the full rally, but I’m comfortable with that trade-off.
The appeal is having an agreed coupon and a defined set of outcomes, rather than repeatedly deciding whether today is the day to buy or sell. I still need to choose the terms carefully. I just prefer doing more of the thinking before buying.
What I’m willing to end up owning
The investments behind the note matter at least as much to me as the coupon.
I tend to favour ETFs over individual companies because I’m more comfortable holding a diversified basket through a downturn. If a note gets knocked in and eventually delivers the underlying ETF, my intention would generally be to hold it rather than sell immediately at a loss.
That isn’t the outcome I’m aiming for, and a recovery is never guaranteed. But I have more confidence in the long-term recovery of a broad equity market than in any particular company returning to its former glory.
It also means I need to be able to leave the money invested. “I’ll wait for it to recover” is a more convincing plan when I’m not relying on that same money for next month’s expenses.
Different notes, different exposures
Across my notes, I’ve used ETFs tracking the S&P 500, Nasdaq and Dow, alongside exposure to gold, gold miners, the US financial sector and Bitcoin.
I spread my investments across different notes, but keep in mind that each note’s outcome usually depends on its weakest underlying. Putting several ETFs into one note doesn’t necessarily make it safer.
Most of my exposure is to broad US equity ETFs, though these often move together. I put smaller amounts into the more volatile exposures, such as gold miners, US financials and Bitcoin. A higher coupon isn’t a reason to buy more than I’m comfortable holding.
Income, with some uneven months
FCNs have been useful contributors to my retirement income, but they don’t produce a salary. Notes can end early, and there may be gaps before replacement investments start paying. I’ve already seen that in my quarterly income figures.
I’ve also experienced a knock-in during COVID. That is a reminder of what I’m accepting, rather than a reason to assume it won’t happen again. I limit the amount in each note and spread maturity dates, while keeping other income sources alongside them.
For me, FCNs work best when I’m comfortable with the underlying investments and don’t expect a strong rally. I can collect income while markets go sideways, without trying to trade every movement.