Flexing fixed income
For the last decade central banks have done their best to punish savers by cutting interest rates to record lows and buying up government bonds. This has pushed yields down and starved many investors of a traditional source of steady income.
On a positive note, Australia has managed to ride out some of the worries about global economic growth and the Reserve Bank of Australia (RBA) has not been forced to cut interest rates to zero, or below, as has been the case in other countries. However, a growing list of domestic worries – housing and high levels of household debt – means that the RBA could easily cut rates this year, putting further pressure on those hungry for income. So how should we think about fixed income in this context?
Cash is not always king
- Having a little extra cash is not always a bad thing. But having too much cash for too long is. Cash may seem like the safest asset to hold, but it will not drive returns or help achieve long run investment goals.
- This hasn’t stopped investors piling into term deposits. The value of cash held with banks has swelled from $276bn prior to the global financial crisis to a record $666bn. This has happened at a time when the average interest earned on that money has dropped from 5.9% to 2.2%. And these rates are only likely to go lower if the RBA progresses with expected rate cuts this year.
The hunt for yield
- Yields on government bonds have touched record lows recently and central banks’ unorthodox polices will keep them low. Approximately 30% of global government bonds yield less than 0%. Put another way, investors are paying for the privilege of lending money to governments.
- Holding government bonds is a good way of protecting your portfolio from losses in equities, but not for finding income. The easy stance that central banks have taken so far this year has reignited the hunt for yield.
- This doesn’t mean writing off bonds completely but looking too the other segments of the market where yields are higher, such as corporate bonds or emerging markets debt.
Cast a wider net
- Fishing with a single line limits the size of your catch. Using a net greatly increases your chances of a better haul. Bond markets are the same. The Australian bond market represents less than 2% of the global bond market.
- Limiting yourself to fishing with one line or in the same place you always have means missed opportunities. Casting the net globally, across different sectors of the fixed income market, greatly increases the income that can be earned and, most importantly, diversifies the sources of income.
- The greatest challenge is knowing where to fish based on the conditions of the day. Being unconstrained and having the flexibility to read the conditions and move between the best spots is key to getting the best income.
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Kerry Craig, Executive Director, is a Global Market Strategist. Based in Melbourne, Kerry is responsible for communicating the latest market and economic views from our Global Market Insights Strategy Team.
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Kerry Craig, Executive Director, is a Global Market Strategist. Based in Melbourne, Kerry is responsible for communicating the latest market and economic views from our Global Market Insights Strategy Team.
Expertise
Kerry Craig, Executive Director, is a Global Market Strategist. Based in Melbourne, Kerry is responsible for communicating the latest market and economic views from our Global Market Insights Strategy Team.
Expertise
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