Investors should consider a balanced allocation to bonds with both fixed and floating rates to achieve stable returns through a period of persistent inflation and uncertain interest rate movements, according to an Australian investment firm.
Income Asset Management credit strategy and portfolio management executive director Matthew Macreadie noted the current yield environment presents an opportunity for investors to lock in higher returns from lower-risk, investment-grade bonds.
“The threat of higher interest rates, slower economic growth, rising inflation and a deteriorating credit cycle is making investing very interesting. However, there are still many income opportunities available in investment-grade bonds, which we have not seen for many years, with 10-year Australian government bond rates at 4.2 per cent,” Macreadie said.
“For investors looking to place capital into bonds at these better starting yields, a choice needs to be made on fixed and/or floating [rates]. At this stage, I’d propose a balanced exposure to fixed and floating, or 50 per cent fixed and 50 per cent floating bonds for new investors, with an overall duration of between three and five years.”
He acknowledged market expectations for future interest rates are already reflected in bond prices, so investors need to be strategic in their allocations. However, he added when done wisely, bonds can also serve as a hedge against potential interest rate hikes, which he expected due to persistent inflation.
“If you think the market is pricing rates correctly or that rates will go higher from here, then you should have a bias towards floating. If you think the market has priced rates too high already, then you’re better off buying fixed. Herein lies the challenge though as the market will inevitably get this decision wrong,” he said.
“It is very hard to have any strong certainty over the inflation outlook, which makes interest rate positioning especially challenging and the need to be appropriately hedged.
“Government and semi-government bonds typically appreciate as economies enter recession and whilst I don’t believe this is a base-case outcome for Australia, it could help offset other losses in your portfolio from equities and property.
“Thus, a small portion of short to medium-term government and semi-government bonds, maybe 10 to 20 per cent, is useful as a hedge.”
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