Fixed-income manager Western Asset, part of Franklin Templeton, has forecast that volatility in fixed income markets will decline this year, giving bonds the scope to provide the defensive characteristics needed to offset the risk of price falls in riskier assets.
Anthony Kirkham, Head of Investment Management/Australian Operations for Western Asset, says that as central banks get to the point where they are ready to hit ‘pause’ on monetary policy tightening, volatility will ease.
“Markets still have a reasonable amount of volatility. As a result, interest rates may provide opportunities for active managers like Western Asset to capture this volatility by opportunistically moving the duration of funds like the Western Asset Australian Bond Fund,” Kirkham said.
“At the same time, if inflation continues to decelerate as we saw over the fourth quarter, this will likely reduce the overall level of volatility in interest rates markets in the year ahead by allowing investors to price a tighter range of central bank response scenarios.
“When you look at the yield to maturity for the Bloomberg AusBond Composite Index at the end of December, it was around 4.8%, which makes bonds and bond funds with conservative characteristics hard to ignore in the context of a diversified portfolio allocation.”
Also read: Why and What If Inflation Falls Faster Than Expected?
The Bloomberg AusBond Composite Index rose 2.8% in January and 2.2 % over the three months prior three months ending 31 January.
Western Asset’s view is that the Australian investment-grade corporate sector is a standout due to the type and quality of issuers.
“Many issuers have strong market positions and have the ability to pass on inflationary pressure,” Kirkham says.
“We’ve seen credit spreads in this segment tighten over the past couple of months, but we believe there is more to go and we remain overweight. We think the economy will continue to slow, but due to the fundamental strengths of these corporate issuers, that they will continue to perform solidly.”
Two areas in particular that Western Asset believes offer value are REITs and bank covered bonds.
“REITs are a standout, mainly because of the very conservative nature of their balance sheets. And they are solid investment-grade names,” Kirkham said.
“Bank covered bonds are basically trading in line with unsecured securities. We find that pricing very attractive. There’s a lot of opportunity there and we will look to continue to actively capture that in the Fund.”
He said underpinning that opportunity is greater certainty at many central banks around the speed, size and extent of monetary policy movements in the current cycle. The Federal Reserve, Bank of England and European Central Bank are among those expected to start reducing their pace of tightening as the impact of higher rates on the economy starts to show in activity levels.
