19 November 2019

    Interest Rates Part 2

    Fixed income still has an important role to play

    David McLeish

    Head of Fixed Income

    Email David
    David McLeish

    Head of Fixed Income

    Email David

    Last month we explored the not so ‘bubbliciousness’ of bonds – and found no clear evidence that the asset class was a bubble.  Nevertheless, in a world of low interest rates, the question remains: does fixed income still have a role to play in my investment portfolio?

    Your financial umbrella

    Fixed income has long provided diversification, stability, and income to an investment portfolio.  This article explains why, despite the low interest rate environment, fixed income still has an important role to play in meeting your investment goals and smoothing out the journey.

    A vital ballast in your investment portfolio

    If share markets always rose then there would be little reason to bother with fixed income.  The reality is though, they don’t.  It is therefore important to have investments in your portfolio that provide an offset in times of turbulence.  It is for this reason most diversified or balanced portfolios include growth assets, such as shares and property, as well as defensive assets, such as fixed income. 

    However, in this low interest rate world, many are rightfully asking; can defensive assets can still provide this valuable ballast to growth assets?

    The evidence certainly suggests so.  Even in countries where interest rates have been negative for years now, this correlation still holds.  Take Germany, where since interest rates first went negative back in 2012, on the weeks when their share market has been down, its average loss was -1.95%.  During those same weeks the German government bond market rose 0.15% on average.

    A durable portfolio needs a strong foundation

    Fixed income assets are very good at maintaining their value over time, as the chart below shows.  It turns out; an investment that is designed to repay the investor in full at a specific time in the future tends to do that.  The stability of global bonds (blue line) demonstrates how bonds thrive at times of economic uncertainty, when shares (the teal line) fall.  It also shows how stable bond returns have been over a long period of time, the last 30 years in this example.

    It is worth highlighting, that lower interest rates should in fact further improved the stability of this asset class.  By making it cheaper for borrowers to service their debt, the likelihood that fixed income investors are repaid on time and in full has improved.

    An insurance policy that pays

    Fixed income assets typically carry explicit and predictable interest rates.  Yes, the level of interest is much lower than we would like.  However, for a quasi-insurance policy like the one described above, receiving any income at all in return for this protection could be considered generous.

    As longer as fixed income assets continue to demonstrate the above qualities, we believe this asset class will keep playing an important role in the pursuit of our clients investment goals.