The Australian fixed income landscape between 2022 and 2023 presents two very different pictures, according to an investment leader at Western Asset, part of Franklin Templeton.
In his latest video update, Anthony Kirkham, head of Australian investment management and operations, said the fixed income landscape has both evolved and returned to being a compelling option for investors.
Mr Kirkham recounted that, “2022 was an incredibly painful year for anyone investing in bonds. It is certainly an interesting year when you compare it to 1994, because ’94 used to be the one we would always talk about. But [2022] was significantly worse, the worst on record”.
“It is not surprising. I guess we all thought it would come at some point based on the fact that you had central banks taking bond yields down to ridiculously low levels, and in some countries even negative, which my brain still can’t really compute.”
At the same time, he added, more money was being thrown at consumers due to both easy monetary and fiscal policy.
“And then, guess what? Inflation, which is what we had been looking for for years, suddenly reared its head. All those programs disappeared and bonds could return to fair value.”
Mr Kirkham explained that, historically, bonds have been an asset class that is always present in portfolios. To say that bonds are “back”, he said, makes sense, but ultimately “they never should have been driven out”.
“[Bonds] were driven out of people’s portfolios because they couldn’t do what they were originally designed to do, which is providing some sort of income, but importantly, provide that defence against risky assets during times of stress.
“It can’t do that if it’s been driven down to zero,” Mr Kirkham said.
“In times of stress, to have that yield curve moving lower and therefore bond price moving higher and providing that offset to risky assets, it can now do, which it couldn’t through that cycle,” he added.
Moreover, Mr Kirkham suggested that the Australian bond market is not well understood.
“Investors don’t know how deep it is. But we see opportunities in the investment grade market. And it can provide real diversification across local companies, the banks, and big infrastructure funds within the Australian market.
“The Western Asset Australian bond fund covers that broad market to provide investors with income and defence when risky assets get a little wobbly.
“Today, we are at a point where most central banks have tried to get inflation back under control. This comes in play as we are seeing a slower global economy,” he concluded.
In June, Schroders Australia’s portfolio manager for fixed income and multi-asset, Mihkel Kase, said: “Bonds tend to do best when growth is falling, inflation is softening, and central banks are easing policy.”
“While we may not see all three in 2023, Schroders believes at least two out of three are likely.”
Also earlier this year, UBS Asset Management’s head of fixed income, Charlotte Baenninger, similarly acknowledged that yields on fixed income assets have finally turned positive.
With income now returning to the fixed income space, she suggested that investors have a number of reasons to be optimistic.
“Over the long term, yield is by far the most stable and reliable component of total return for bonds,” Ms Baenninger said.
“Over the past 20 years, yield (income) has been the dominant driver of total returns in bond portfolios. For certain asset classes such as high yield and emerging markets, price return has been negative over the long term yet performance has been positive and very strong, demonstrating the power of yield.
“Despite the large role yield plays in total return, it only contributes a minor proportion towards total return volatility.”
