Investors and financial advisors might be overstating the potential downside risks of owning local fixed income and underplaying the diversification benefits of the asset class, says Simon Warner, AMP Capital’s Head of Fixed Income.
“Although the Fed [US Federal Reserve] will continue to raise rates, the RBA [Reserve Bank of Australia] will continue to be slow,” Warner says, highlighting that investors in the local fixed income market should not understate the protection bonds provide if there’s an equity market downturn.
“Our view is you need to be very balanced about the two goals for fixed income – be very clear about where fixed income portfolios are giving you the yield and income you need, and where are they giving you defence,” Warner says
When it comes to risks in fixed income and balanced portfolios containing fixed income, duration is what most investors are worried about at this stage of the cycle, Warner notes.
Investors might be worried about rising interest rates and what that means for the value of their bond portfolios, assuming that interest rates are about to spike and inflation is about to emerge and that it’s a really dangerous time to own duration in fixed income, Warner outlines.
“At this stage of the cycle, duration is a hot topic and it’s something we talk to consultants and customers about all the time,” Warner says.
Warner defines duration as the sensitivity of bond prices to interest rates.
Clearly, we’re well into the latter stages of the investment cycle, Warner explains.
Phase one of the cycle is the recovery phase, where interest rates are kept very low and there’s an acceleration in economic activity.
Second phase is where everything is pretty stable, where there’s no pressure on interest rates to go up because inflation hasn’t emerged and growth is very solid.
The latter phase is when there’s more pressure on interest rates to go up and investors need to be more mindful of when the cycle might eventually end, Warner explains.
Investors might be worried about holding inflation if they see the US Federal Reserve increasing rates, they think the RBA will be soon to follow and they worry about negative total returns to fixed income, Warner notes.
The benefit that bonds give you when there’s an equities correction shouldn’t be underestimated, he says.
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