The current economic environment is creating a shift to fixed income and cash investments, which is likely to be short-lived as investors pull back from being overly defensive, according to investment manager Vanguard.
Vanguard global chief economist Joe Davis said rising interest rates were making the efficient frontier, where an investment portfolio is expected to provide the highest returns at a set level of risk, steeper in comparison to cash and improving the case for fixed income investments.
“This may seem like a disconnect to certain investors because they hear ‘rising rates’ and they have an aversion to fixed income, but we have positive real rates across the term structure [or yield curve] of fixed income,” Davis said.
“In the United States we are seeing a drift to fixed income for income-sensitive investors and it is a powerful attraction because they are realising they have now nominal yields that are 5 or 6 or 7 per cent for the time being,” Davis said.
“Interest rate policy is encouraging investors to, instead of going towards the zero balance, take greater risks, so we are seeing more normalisation into fixed income.”
Vanguard Australia head of financial adviser services Rachel White said there was a similar trend in Australia, but warned short-term portfolio shifts due to markets could lead to investors missing out on larger gains.
“Towards the second half of last year, we saw a pick-up in terms of flows into fixed income and this year there has been more going into the cash bucket,” White said.
“That does reflect some of the consumer sentiment we were seeing at the start of the year, but looking at returns through January it can be dangerous moving into cash tactically.
“Joe’s team did some work on looking at the best days in markets and how they typically follow the worst days. It’s important to remember those timeless investment lessons around time in market and keeping that diversified asset allocation and not weighting too heavily in cash in this current environment.”
She said investors may have placed money in cash for the short term as they did not seek investments up the risk curve and many were already moving out back to other asset classes.
“It has been surprising at how risk off the sentiment has been and how short-lived that is. There is a bit of a slow start to the year and we see them coming back in and inflows normalise. We saw a similar situation last year, in terms of January flows, and then a pick-up in terms of Australian shares and diversified investments became much stronger throughout the year,” she said.
“We are optimistic that will be the case this year, but there has been a severe six weeks to the start of the year, in terms of people moving into cash, and there are still a lot of questions around sitting in term deposits and if that is a safer investment, with advisers having to coach clients through the return to market.”
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