Fixed income investments have bounced back from their worst period for returns in decades and have returned to playing a defensive role opposite shares, but ongoing market volatility may undermine that recovery, according to an Australian fixed income manager.
AMP fixed income portfolio manager Chris Baker recognised last year ranked as one of the worst years since World War II for a 60/40 shares/bond portfolio, but many of the conditions causing that had shifted.
“If you go back a number of years, we had zero interest rates and central banks were talking about transitory inflation and that’s really changed, but on a backward-looking basis 2022 was the worst year for fixed income returns in 70 years,” Baker said.
“On a forward-looking basis, bonds are far more attractive as we’ve seen central banks aggressively increase interest rates to combat inflationary pressures and we’re starting to see moderation in inflation.
“Pleasingly, when we look at one-year returns, it’s [all positive] and that’s largely a result of the income which is being captured given we’ve seen the reversion in the interest rate.
“Even though we’re seeing continued upward pressure in bond yields, the starting level of income is far more attractive and government-related sectors and [corporate] credit-related sectors are all positive.
“The general theme has been that credit has outperformed government bonds, and bond yields and movements in interest rates really have driven the market.”
“On a forward-looking basis, with central banks getting close to terminal levels [of interest rates], there’s still upside risks to further rises in yields, but where we’re sitting now if you look at a US Treasury portfolio bond, it’s now yielding roughly 5 per cent and investment-grade corporate bonds are yielding 6 per cent.
“So the starting point from when you’re investing now versus a couple of years back is far more attractive.
“There clearly still are risks, but bonds are far more attractive and the correlation benefits should return and provide diversification in the event of a risk-off environment.”
He noted while volatility in the bond market had fallen, it was still a factor to consider given the current macroeconomic and global political situation.
“We are still bouncing between how far will bond yields rise and will central banks hike rates if inflation remains sticky,” he explained.
“On the other side of the equation is a potential slowdown, so bond markets have been whipsawed between risk-on and risk-off and geopolitical events will create ongoing bouts of volatility.
“Last year was terrible in how volatile it was and we’ve reverted from those levels, but it continues to be a challenging environment for fixed income.”
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