Markets have been unsettled in recent weeks. Share prices have slipped while interest rates and bond yields have moved higher, and many investors are asking whether their portfolios are positioned appropriately. Here is a plain-English look at what is happening and why it is prompting renewed interest in fixed interest.
What has been happening
The Reserve Bank of Australia lifted the cash rate to 4.60% at the end of September, its fourth increase this calendar year and 1.00 percentage point of tightening in total. The RBA pointed to stubborn inflation, higher global energy prices and pressure on domestic capacity, and indicated it will do what is necessary to bring inflation back to target.
Equities have felt the pressure. On 1 October the S&P/ASX 200 fell close to 2% in a single session, to its lowest level since mid-June. Rising global bond yields were a key driver, with the US 10-year Treasury yield reaching its highest levels in many years and oil prices remaining elevated. Higher yields tend to weigh on share valuations because future company earnings are worth less when measured against a higher return available from safer investments.
Why higher rates matter for fixed interest
Fixed interest investments, such as government bonds, corporate bonds and bond funds, pay income based on prevailing interest rates. When rates and yields rise, newly issued bonds offer more income than they did a year or two ago. For investors building or topping up a fixed interest allocation today, the starting yield is considerably more attractive than the very low rates seen in the years after the pandemic.
Fixed interest can also play a stabilising role. Over time, the returns from defensive assets have often behaved differently to shares, and the regular income they provide can help smooth overall portfolio returns when equity markets are volatile. This is the traditional diversification benefit that a mix of growth and defensive assets is designed to deliver.
The risks still need to be understood
Fixed interest is not risk free, and the current environment illustrates why. The key points to understand include:
- Interest rate (duration) risk: when yields rise, the market value of existing bonds generally falls. Longer-dated bonds are more sensitive than shorter-dated ones. If rates keep climbing, bond prices can fall further in the short term.
- Credit risk: corporate and lower-rated issuers may fail to meet their payments, so quality matters. Government and high-grade issuers generally carry less credit risk, but usually offer lower yields.
- Inflation risk: if inflation stays high, the real (after-inflation) return from fixed interest can be eroded.
- Correlation risk: in periods when inflation is the main concern, shares and bonds can fall together, so fixed interest does not always cushion a downturn.
These factors are why the choice of fixed interest matters. Maturity, issuer quality, the mix of domestic and international exposure and whether you hold bonds directly or through a managed fund can all produce very different outcomes.
What this means for different investors
For clients in or approaching retirement, a stronger fixed interest allocation can help fund income needs without having to sell growth assets after a fall in the market, which helps manage sequence of returns risk. Clients with a longer investment horizon may view lower share prices as an opportunity to keep investing for growth, while using fixed interest to rebalance and manage risk. In either case, a portfolio should reflect your goals, your timeframe and how much volatility you can comfortably accept, rather than reacting to headlines.
It is also worth remembering that markets are forward looking. Economists differ on when the RBA may stop raising rates and when cuts might begin, and market conditions can change quickly. Diversification and regular reviews remain more reliable tools than trying to time the market.
Speak with an MLS Financial adviser
If recent market movements have you wondering whether your asset allocation still suits you, now is a good time to review it. The advisers at MLS Financial in Penrith have been helping clients with investment and retirement planning for over 20 years. Contact us to discuss how fixed interest could fit within your overall strategy.
Written by:
Adrian Guy – BBus (Finance & Economics), MLS Financial
Disclaimer:
This information is general in nature and does not take into account your personal objectives, financial situation or needs. You should consider speaking to a qualified financial planner before making any financial decisions. MLS Financial and Infocus Securities Australia Pty Ltd do not accept responsibility for actions taken based on this content.