Portfolio Q&A: Income Fund
Flexibility is at the heart of our approach to fixed income markets.
FIXED INCOME IN AN INFLATIONARY WORLD
Prolonged inflation, central bank tightening and slower economic growth will likely persist, prompting some investors to work harder in the search for more attractive income prospects1.
Inflation remains a key focus amid tight supply chains, semiconductor shortages, higher energy and food prices and rising wage costs. In Australia, the annual consumer price index rose to 5.1% in the March 2022 quarter3 because of higher housing construction costs and fuel prices. The Reserve Bank of Australia has responded to this higher inflation by increasing rates to 0.85%4 in June 2022. This is matched by the US Federal Reserve (Fed) as they are likely to continue raising rates over the balance of 2022. We believe the Fed will look to get to at least 3% on the policy rate as quickly as possible before reassessing the fundamental backdrop.
In today’s environment, it’s crucial to employ an unconstrained and flexible approach to differentiate and invest where opportunities can be found – with a particular focus on seeking quality and higher yielding allocation ideas.
FIXED INCOME SOLUTIONS IN AN INFLATIONARY WORLD
WHERE WE SEE OPPORTUNITIES
1. Diversifying across the fixed income spectrum
An unconstrained approach can help identify the high-conviction investing ideas for a diversified fixed income portfolio.
As market conditions evolve, allocating across the full fixed income spectrum - traditional assets such as government and investment-grade (IG) bonds as well as non-traditional assets such as securitied5 credit and high-yield6 (HY) corporate bonds - can help build a resilient and diversified portfolio.
Investors should consider how they allocate to each fixed income market segment as the difference in drivers of return, sensitivity to interest rate movements and corporate fundamentals will affect returns. Having the flexibility to move between sectors may be advantageous.
2. Actively managing duration7
In fixed income investing, duration is a gauge of interest rate risk, showing how bond prices and yields will likely change when rates move. Generally, longer duration bonds may suffer more price decline in response to a rise in interest rate. Therefore, duration positioning has served both as a risk management8 tool as well as a source of alpha.
We prefer high quality, short-duration bonds. We believe government bonds can be a place to add duration. Yields on 10-year US Treasuries more than doubled this year, as of 8 June 2022, and should offer some flight-to-quality benefits at a yield above 3%9. If Fed expectations shift to a higher terminal rate, we believe the front-end of the Treasury market would absorb most of the repricing, with the back-end remaining stable.
Our research encompasses fundamental, quantitative and technical analysis
Our risk management discipline is essential to our investment process.