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Attractive investment opportunities as bond yields top 3.5pc

Emma Rapaport  |  22 May 2018Text size  Decrease  Increase  |  
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With bond yields rising and the lowest correlations between fixed income and equities returns in years, here's what the smartest people in the room told Morningstar last week.

PIMCO co-head of Asia-Pacific portfolio management Robert Mead says while he views yield prediction around 4 per cent as "unrealistic", bonds are on course to reach the 3 per cent to 3.5 per cent range for the rest of the year,

Addressing a Bloomberg Investor summit in Sydney, he says: "We do think that this hiking cycle is already well advanced. Six hikes already, and there's another three or four that the market is already acknowledging".

"We also know that the backdrop of the U.S. economy has been pretty strong and going for a long time. At some point we're going to find that these heightened yields start to become an impediment to growth."

On Tuesday last week the US 10-year bond yield crept above 3 per cent for the first time since early-2014, sending fund managers and analysts into a frensy to debate its significance. It peaked at 3.11 per cent on Friday, before lowering to 3.05 per cent today.

Historically 3 per cent has been viewed as an attractive level for more cautious investors, meaning they are more likely to switch out of risk assets like equities and entrust their savings to the safety of the US Government.

Mead says that higher yields represented an opportunity for Aussie investors to start moving their strategic asset allocation back into fixed interest.

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"I think the most important takeaway for Aussie investors who have been heavily underweight the fixed income asset class is that we've already been through six rate hikes from the fed," Mead says.

"There's always this very strong chorus out there about bond bear markets, and how dangerous it is, yet throughout that period bonds have still generated positive returns.

"So as yields get higher and higher, this is a great opportunity for Australian investors to start to move back towards their strategic asset allocation that they've been so heavily underweight for so long."

Vanguard head of Asia-Pacific fixed income, Jeffery Johnson, largely agrees with Mead, putting its fair value of US ten-year bond yields between 3 and 3.25 per cent.

Longer term inflation expectations are being anchored by very powerful structural forces including globalisation, technology and demographics should keep a ceiling on how high interest rates are likely to go, Johnson says.

Pivoting away from yields, GAM Systematic co-head Anthony Lawler sees value in holding elevated levels of cash, in an investment environment characterised by geopolitical risks and rising inflation.

"Holding cash when you're earning about 2 per cent is much more comfortable thing to do than earning 0, so we would encourage investors not to underestimate the value of holding that cash because it gives you flexibility.

"We don't see any sort of screaming buys even with some of the volatility you see in the first quarter," Lawler says.

"We continue to see value in diversification away from simply different forms of betting on global growth, absolute return in bond funds for example."

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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