According to Western Assets, fixed income markets are expected to experience lower levels of volatility this year, which could offer bonds an opportunity to demonstrate the defensive features required to offset the potential downside risks associated with riskier assets.
Western Asset head of investment management and Australian operations, Anthony Kirkham, said that volatility will ease as central banks reach a point where they can hit “pause” on monetary policy tightening.
“Markets still have a reasonable amount of volatility. As a result, interest rates may provide opportunities for active managers like Western Asset to capture this volatility by opportunistically moving the duration of funds,” Mr Kirkham explained.
“At the same time, if inflation continues to decelerate as we saw over the fourth quarter, this will likely reduce the overall level of volatility in interest rates markets in the year ahead by allowing investors to price a tighter range of central bank response scenarios,” he added.
Mr Kirkham highlighted the yield to maturity for the Bloomberg AusBond Composite Index, which sat at around 4.8 per cent at the end of December. Moreover, the index rose 2.8 per cent in January and 2.2 per cent over the three months prior ending 31 January.
This example, he said, makes bonds and bond funds with conservative characteristics hard to ignore in the context of a diversified portfolio allocation.
According to the fixed income manager, the Australian investment grade corporate sector is unique due to the type and quality of issuers.
“Many issuers have strong market positions and have the ability to pass on inflationary pressure,” Kirkham said.
“We’ve seen credit spreads in this segment tighten over the past couple of months, but we believe there is more to go and we remain overweight.”
Western Asset’s view is that while the economy will continue to slow, corporate issuers will continue to perform solidly.
Meanwhile, Western Asset believes that REITs and bank- covered bonds will continue to offer value.
“REITs are a standout, mainly because of the very conservative nature of their balance sheets. And they are solid investment grade names,” Kirkham said.
“Bank-covered bonds are basically trading in line with unsecured securities. We find that pricing very attractive. There’s a lot of opportunity there and we will look to continue to actively capture that in the fund.”
Behind these opportunities is greater certainty from central banks around the speed, size and extent of monetary policy movements in the current cycle, he added.
Namely, according to Mr Kirkham’s assessment, the Federal Reserve, Bank of England, and the European Central Bank are among those expected to start reducing their pace of tightening as the impact of higher rates on the economy starts to show in activity levels.
