The global response to COVID-19 unleashed a wave of fiscal stimulus and set into motion the beginning of the end for the prevailing ultra-low interest rate environment.
From supply chain disruptions to a dramatic increase in the global money supply, the dynamics of the global economy have undergone seismic changes, ushering in a new era of sticky inflation, greater geopolitical uncertainty, and higher interest rates.
As the hangover effects of lockdowns and stimulus measures subside, the economic outlook remains uncertain with inflation and interest rates potentially staying higher for longer. While this has led to extreme volatility and in some cases, massive value destruction in many speculative growth assets, fixed income securities are now providing some of the best yields in decades.
Fixed Income Securities – Why Now?
For many years, fixed-income securities including bonds have been largely relegated to the sidelines as retail investors have piled into equities and other riskier growth assets. Today however, with interest rates surging to combat persistent inflation, interest in fixed income securities is garnering increased attention.
Since March 2020, the yield on the 10-year Australian Government Bond has increased by more than 630%, rising from circa 0.568%pa to 4.128%pa, and yields on corporate fixed-income securities have increased even more. This means advisers no longer need to be searching the exotic corners of financial markets to secure stable and regular returns for their clients.
Reliability Amid Uncertainty
In periods of economic stagnation and uncertainty, equity investors can find themselves exposed to significant portfolio volatility as companies come under pressure to maintain earnings growth. Not only can dividends be slashed as companies tighten the purse strings, but share values can decline or flatline.
For example, in the calendar year to date, the S&P ASX/200 currently trades just 1.2% (at the time of writing) above its yearly open.
In such an environment, corporate fixed income securities can play a pivotal role in maintaining portfolio stability given they tend to move inversely to equities while also providing a regular and stable income stream, irrespective of price and/or market conditions.
While this income isn’t guaranteed, especially in the event that the issuer defaults on its obligations to pay creditors, when it comes to corporate fixed-income, the returns and the most likely outcomes are known upfront.
Understanding the Risks
While bonds are generally less volatile than equities, they aren’t without risk. From credit risk to market risk and inflation risk, there are many considerations to be aware of.
Interest rate risk: When interest rates increase, they cause the price of fixed-income securities with a fixed rate (as opposed to a floating rate) to fall. In such a scenario, if you needed to sell your client’s bond or other fixed interest security for them, the market price for the securities may be below what was initially paid. Interest rate risk is only a risk for investor who sell their security before its maturity.
Credit risk: This is the risk that the issuer of the fixed-income security defaults or is unable to pay on time. Different fixed-income securities have varying levels of credit risk as there are various internal and external influencing factors.
Inflation risk: Inflation erodes the purchasing power of future cash flows, including bond coupon payments and principal repayments. Fixed-rate bonds are particularly susceptible to inflation risk, as the purchasing power of their future income streams decreases over time in an inflationary market. Advisers should therefore consider inflation expectations when assessing the suitability of bonds in their portfolios.
Strategies for Investing in fixed-income securities
Whether you simply buy and hold fixed-income securities until maturity, employ laddering strategies, or actively trade and speculate on assets to capture any price appreciation benefits, there are many roles which corporate fixed-income securities can play within client portfolios.
For more information about how corporate fixed-income securities can benefit you and your clients, speak to an ABE adviser today.
Data as accurate as 11.09.2023
Disclaimer: Australian Bond Exchange Pty Ltd ACN 605 038 935 AFSL 484453 (ABE). This article is intended to provide general information of an educational nature only. It does not constitute the provision of personal advice and does not take into account your personal objectives, financial situation or needs. Before investing with ABE, you should consider the appropriateness of the investment to your particular financial and taxation situation and consider obtaining independent advice before making an investment. Examples in this article are for illustration purposes only and are not a recommendation to buy, sell or hold a particular investment. ABE makes no representation or guarantee as to the availability of a bond with the characteristics described in this article or that an investment made by you will generate the returns in the illustration. Past performance is not an indication of future performance. Investing with ABE is subject to our Client Services and Custody Agreement Terms and Conditions and Financial Services Guide.