New income opportunities: from TINA to TARA
Bonds are Back
The dramatic surge in bond yields that has followed the interest rate hiking cycles of central banks have finally created some opportunities in the fixed-income space for investors with a lower appetite for risk. We have made the jump from an era of TINA (There Is No Alternative) to TARA (There Are Reasonable Alternatives).
Today, the cash and fixed-income asset classes offer the highest yields seen in the last 10-15 years thanks to the post-COVID surge in global inflation, which has prompted a break in the interest rate regime from the prior Zero Interest Rate Policy era that persisted from 2009 to 2022.
Given the likelihood that inflation rates will settle in future at a higher level than experienced in the years post the Global Financial Crisis, we favour investment in inflation-protected sovereign bonds, given today’s elevated real yields.
Investable sub-themes of this secure income theme include:
- Sovereign bonds: US and UK government bonds with maturities of around 5 years, with a preference for Treasury Inflation Protected bonds (TIPs) and index-linked gilts:
- Corporate credit: investment grade corporate bonds in the US for USD-based investors: investment grade corporate bonds in the eurozone, with a preference for bonds issued by companies with solid balance sheets
- Emerging Market local currency sovereign bonds;
- Income-focused structured products;
- Equities: with a focus on solid companies that deliver growing dividends
- Interest rate risk. Inflation has proved difficult to predict. A slower-than-expected decline in inflation will force the Federal Reserve and the European Central Bank to keep hiking rates, pushing bond yields higher and bond prices lower. This is the so-called interest rate risk i.e., the potentially negative impact of the change in market interest rates on the bond price.
- Credit risk. Aggressive central banks may push economies into recession. Long-term bond yields would drop but corporate credit spreads would widen materially, and corporate bankruptcies would increase. The credit risk is the capacity of an issuer to honour its commitments: downgrades of an issue or an issuer’s rating may lead to a drop in the value of associated bonds.
- Liquidity risk is the risk that an investor will be unable to sell a bond before maturity, or will only sell it at a much lower price than expected.
- Currency risk is the risk of making a loss due to the fluctuation of the currency used for the bond issue, in comparison with the investor’s reference currency.