Investors eye higher interest and capital growth from fixed income

Fixed income was a 2022 investment ugly duckling, but the year ahead looks promising for people seeking solid returns.

Investing in fixed income has been challenging in recent years. Picture: iStock

Fixed income assets are reshaping Australia’s investment landscape and 2024 could be a sweet spot for this often-confusing asset class.

After being the investment world’s ugly duckling in 2022 and experiencing further pressure this year, bond returns are forecast to bounce back next year amid ongoing high interest rates and the prospect of rate cuts by central banks.

The range of fixed income investment options is large and growing, stretching from government bonds and corporate bonds to mortgage-back securities and insurance linked securities, which are instruments linked to weather events that transfer risk from reinsurers to investors.

A Schroders investment briefing has been told that “the income is back in fixed income” and that some fixed income investments would potentially deliver higher returns than equites over the next three years.

Many fixed income investors have been squeezed in the past two years. Picture: iStock

Investors could now get equity-like returns from fixed income with a lower risk than equities, said Schroders CEO Simon Doyle.

Its head of multi-asset, Sebastian Mullins, said the next 10 years were likely to feature higher inflation and higher volatility than the low rates investors had experienced over the past decade.

This meant returns from bonds should be higher and the cost of capital would go up, so earnings and stock selection would matter again, he said.

“When interest rates are so low you can survive for many years without making any money as long as that expectation money is coming in the future,” Mr Mullins said.

“When cash rates are higher and the cost of capital is higher, you have to earn money quicker to pay off your debts.”

This would lead to fewer zombie companies, particularly among US tech stocks, Mr Mullins said. “Some companies like Google and Apple are doing phenomenally well, but there’s also a bunch of unprofitable tech that also did really well in the past decade. That stops – with higher interest rates those companies cannot survive any more.”

Mr Mullins said 2022 showed that fixed interest could be a risk asset.

Bond investments went backwards, suffering their worst performance in decades, when central banks raised interest rates sharply, giving new bonds higher yields and reducing the values of existing bonds that pay lower yields.

Zenith Investment Partners head of asset allocation Damien Hennessy said 2023 had lacked the 2022 pain but bonds still struggled as “yields have kept rising”.

Continuing rate rises this year have taken the shine of what was tipped to be a strongly-performing asset class in 2023, he said.

“At the start of the year markets were confidently pricing in rate cuts from mid-2024 onwards,” Mr Hennessy said.

“Progressively they have unwound that, and that’s led to bond yields pushing higher again and capital losses,” he said.

“Going into 2024 bonds look a far better prospect than they have been for some time.”

Higher bond rates impact assets such as shares and property. If you can get 5 per cent risk-free from a 10-year government bond yield, shares and other investments must do better to be more attractive.

“It sets hurdle rates higher for investing in other assets, like equities, as well – other asset classes are adjusting to reflect that,” Mr Hennessy said.

Fixed income fund Blossom’s CEO, Gaby Rosenberg, said bonds could confuse everyday investors because of their complexity, volatility and lack of access.

“There are government bonds, corporate bonds, municipal bonds, mortgage-backed securities, and asset-backed securities,” she said.

Blossom CEO Gaby Rosenberg says the bond market has a positive outlook. Photo: Supplied

“Each of these types of bonds has different risk and return profiles. The Blossom fund alone has over 500-plus exposures globally – it’s a very complex market.”

Ms Rosenberg said there had been a growing trend of everyday investors buying into fixed income through exchange traded funds and diversified bond funds.

“In the past, fixed income investments have been largely out of reach for everyday investors. This is because bonds have traditionally been traded in large denominations and have required high minimum investment amounts.

“Given interest rates are still rising, the equity and property markets are looking shaky. The bond market is facing considerable disruption as well but there is still a positive outlook and it’s a good choice for investor money right now.

“The key for fixed income is accessibility and education. If fixed income plays a part in the portfolio of many sophisticated investors and high net-worth individuals, why shouldn’t it play a role in the portfolio of the everyday retail investor?”