The end of the monetary easing cycle could take a heavy toll on passive bond portfolios, warns Henderson Global Investors.
In his outlook for 2017, Henderson head of Australian fixed interest Glenn Feben said Australia is close, if not at the end, of the monetary easing cycle.
"While the Australian economy is continuing to perform reasonably well, as we move through 2017 and beyond, we can expect to see a meaningful slowdown in residential construction, especially in the apartment sector," Mr Feben said.
"This will require other parts of the economy to take up the slack and how this unfolds will be central to how the Reserve Bank of Australia will manage policy over the next few years."
Investors must be "realistic" about the returns fixed interest will deliver in the future, Mr Feben said.
"It is fair to say that just how far bond yields have fallen around the world has surprised many and this has allowed returns from bonds to hold up reasonably well over recent years," he said.
"Investors need to recognise that this tailwind to fixed income performance is receding and may well change direction in the years ahead.
"If we do head into a rising yield environment, with yields so low, there is minimal income to protect investors from the negative impact of higher yields on bond prices."
Investors who hold bond index funds should be particularly concerned, considering that yields are at historic lows and duration is at an all-time high, Mr Feben said.
"Fixed income strategies that focus more on absolute performance rather than relative to a benchmark are likely to fare considerably better in a rising yield environment," he said.