With inflation having likely already peaked in the US, Zenith Investment Partners has suggested that now may be a good time to consider adding duration back into portfolios.
Calvin Richardson, an investment consultant at Zenith Investment Partners, noted that the annual rate of inflation declined to 7.1 per cent in November according to the latest US figures, representing a sharp fall from the peak of 9.1 per cent reached in June this year.
“Despite remaining uncomfortably high, markets are intent on buying any suggestion that inflation has peaked and that the path of interest rate hikes will moderate,” he said.
“This was on display when the October print was released and the tech-heavy Nasdaq soared 7.4 per cent in one day.”
During recent discussions with portfolio managers about inflation and fixed income markets, Mr Richardson indicated that the common theme has been a move to add duration.
The improved global economic backdrop over the past 12 months, he said, has resulted in a powerful rise in inflation.
“Consequently, central banks have responded by aggressively increasing interest rates to choke off demand within the economy, which flows through to higher bond yields,” said Mr Richardson.
“Higher bond yields have a contractionary effect due to higher borrowing costs for individuals, governments and businesses which then discourages investment and spending. Due to the inverse relationship shared between yields and the capital value of bonds, this has prompted bonds to reprice heftily lower.”
While Zenith’s portfolios have benefited from being intentionally positioned with lower duration than the benchmark, Mr Richardson said that the firm has recently moderated this positioning in light of the newly attractive bond yields that are available.
“The washout in fixed income markets, while painful, has led to the normalisation expected to unfold over a longer period,” he said.
“This has dramatically reinvigorated the defensive qualities associated with fixed income due to the higher starting yields, which makes the asset class significantly more appealing for us.”
Mr Richardson also suggested that, if a recession does take place when rates are cut, having more interest rate sensitivity means that the value of bonds will rise and the negative correlation between bonds and shares should reassert itself.
Meanwhile, the Zenith investment consultant said that he observed division among fund managers regarding the outlook for private assets as a result of the erroneous perception that they offer greater safety than their publicly listed counterparts.
“The primary difference comes down to how the two are traded, with publicly listed securities offering liquidity on a public exchange, such as the ASX 200, whereas private assets are exchanged infrequently between two or more private counterparties,” Mr Richardson said.
“This is particularly topical given the scrutiny around the performance profile of our local industry super funds, with question marks around the lack of write-downs to date on their private assets.”
