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Rising personal debt, inflation top of mind for bond managers

Morningstar  |  31 May 2018Text size  Decrease  Increase  |  
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Historic levels of global indebtedness and rising interest rates were among key topics discussed by credit market experts at this year's Morningstar Investment Conference.

Investors are heading into a period of unease in the fixed income sector, according to two panel session participants, Brad Boyd, senior vice president at Payden & Rygel Investment Management, and Brett Lewthwaite, Macquarie Investment Management's co-head of fixed Income. While they agree on the above point, their views differ on the specific causes and how investors should be positioned to mitigate the risks.

The pair addressed these issues during a panel session at the conference, which was held in Sydney last Thursday.

Boyd believes rising interest rates and inflation, and diminished diversification, required investors to increase their creativity around how they achieve fixed income exposure. This includes considering assets other than long-duration government bonds. Referring specifically to government bond index funds, he says "this old umbrella won’t work."

Taking a different view, Lewthwaite signalled the need for protection against risky assets – particularly equity and corporate debt – which he believes are carrying "lofty valuations". As an example, he suggests investors could increase their holdings of duration and government bonds.

Their contrasting perspectives reflect the two asset management firms' different approaches. Payden & Rygel draws from a variety of opportunities across different parts of the credit universe, while Macquarie follows a more conservative approach.

Rising interest rate 'hurricanes'

Boyd and Lewthwaite adopted a more measured tone than the conference's opening keynote speaker, Franklin Templeton's Michael Hasenstab, who spoke of a "perfect storm" in global financial markets. This included rising interest rate "hurricanes", as he put it, and an unwinding of the US Federal Reserve's balance sheet.

The credit specialists agreed the historically high indebtedness of countries will exacerbate the effects of rising interest rates, with "debt and rising interest rates not natural dancing partners," according to Lewthwaite.

hurricane volatility perfect storm

Global markets face rough weather, says Franklin Templeton's Michael Hasenstab

They were less concerned by the impact of the unwinding of the Fed's bond portfolio, highlighting the Fed's US$4.5 billion bond purchase program exemplifies it as "unlike any other regime".

Lewthwaite and Boyd suggested the unwinding effect won't be overly dramatic, in responding to a question about where the shortfall in purchases will come from "when the Fed doesn't show up". This is largely because the Federal Reserve is constrained by how fast it can raise interest rates.

Lewthwaite argued this scepticism is already "baked into fixed income security prices", reflecting his contrarian position within the space. He believes risk assets is where investors "will feel the pain", because this is where valuations are the most stretched, particularly within corporate debt and growth assets such as equities.

Discussing inflation, Boyd argued upward pressure on wages in the US has been driven by increasing levels of employment, which will negatively affect bonds.

While also cautious on rising inflation, Lewthwaite was less concerned. He argued markets outside the US are yet to feel the effect of these inflationary pressures, questioning whether there indeed will be an inflation breakout as many in the industry are predicting.

Lewthwaite believes demographics and digitalisation will "snuff it out", and so the impact on traditional long-duration government bonds is not as damaging.

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© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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