Thomas Moore, Co-Head of Fixed Interest at Invesco, shares his thoughts on fixed income investing in the current inflationary environment.
How are you positioning against this inflationary backdrop?
“We are very fortunate in that we run a series of fixed income mandates that are not benchmark-oriented, and which give us a degree of flexibility around how we allocate assets within our portfolios. So, we’ve been able to be quite flexible with respect to our duration positioning and kept the portfolios relatively at the shorter end of the spectrum in 2021 and into this year, in anticipation of higher rates.
“We also run a lot of funds which allow for balancing allocations among different subcategories of fixed income and so, where it’s been useful to pursue higher yields as another hedge against higher rates, we’ve been able to do that.
“We’re a little bit less concerned about credit quality at the moment. Not to say that we are stretching for yield but, in 2022, at any rate, we are a little bit less concerned about defaults. We believe we might see an upward bias in credit quality as rates rise and as the trade-off between duration and income becomes a little bit less clear than it is now.”
What about risks? What’s the worst-case scenario in terms of central bank policy?
“There is potential for overreach by central bankers and overshoot in terms of policy adjustment that’s poorly communicated to the market. At present, there are a generation of central bankers who are certainly conscious of the impact that their words can have on asset prices and on market volatility, but some of the lead governors are not as seasoned as one might like and have certainly shown themselves to be capable of poor communication to the markets. The worst-case scenario would be an excessive hiking of rates that markets don’t anticipate and that leads to real damage to portfolio valuations.”
As rates rise, is fixed income an attractive place to be?
“Even in an environment of rising rates, income in the world that we’re living in is very hard to come by. Therefore, a fixed income portfolio with the flexibility to allocate among different subclasses of fixed income can be a very effective in generating the kind of income required to fulfil various financial goals.
“Although the negative correlation between government bonds and stocks has broken down over recent years, were we to enter a more normal rate environment, say over the next couple of years, we believe that traditional hedge would reassert itself. This could put investors back into the position that they were traditionally in pre-global financial crisis where they thought of the bond portion of their portfolio as an offset to anything happening on the equity side.”