Higher for longer – Why you should be considering Corporate Fixed-Income

With corporate fixed-income securities now offering some of their most attractive returns in over a decade, the opportunity cost of having no exposure for your client’s portfolios has become material.

Since the Global Financial Crisis (GFC), artificially suppressed interest rates through quantitative easing have significantly distorted the dynamics of financial markets. For bonds and other fixed-income securities, this resulted in a continuous suppression of yields which also significantly pushed up growth assets to eye-watering valuations.

Today, however, we live in a very different environment where interest rates are now sitting at levels that we have not seen for many decades while many over-inflated assets have experienced large markdowns.

Subsiding inflation

The COVID-19 pandemic and associated forced lockdowns upended economies across the world and triggered a seismic shock to the global supply chain. The imbalances which this created, combined with record government stimulus, led to an explosion in inflation which was expected to be transient, but has ended up being far stickier than anticipated.

While escalating geo-political tensions stemming from Eastern Europe and the Middle East threaten to derail central bank efforts to date, after 11 interest rate hikes in the U.S., 13 in Australia, and 10 in Europe, inflation is still undeniably trending lower.

 Global Inflation, Annual Percent Change (Advanced Economies)

Last week we saw both the U.S. Federal Reserve and Bank of England hold rates once again as rate setters attempt to strike the right balance between controlling inflation and preventing an economic hard landing.

Tomorrow, the Reserve Bank of Australia will decide whether to raise the official rate after elevated September quarter inflation data. Whether Governor Bullock raises rates this week or not, the prevailing view from many is that we are nearing the top of the interest rate hiking cycle, and this presents a unique and timely opportunity for savvy fixed-income investors.

Corporate Fixed Income- Why Now?

In comparison to equity markets which have been choppy and indecisive, high-quality corporate fixed-income securities have been paying stable, consistent, and regular returns between 6 – 8%pa.

Unlike dividends which can be scrapped at the discretion of company management, corporate bonds and other credit-linked securities are debt obligations, requiring the issuer to pay investors an agreed amount over a defined time period.

While it’s true that short-term money markets are also providing attractive rates, in an increasingly uncertain environment, securing a consistent income stream with longer-dated maturities could be a prudent decision.

This is especially true for investors who might be looking to transition into retirement or who just want to augment their existing income.

Higher for Longer

With interest rates inching ever closer towards their pinnacle, investors with little-to-no exposure to corporate fixed-income could be overlooking a significant opportunity to lock in desirable rates ahead of any potential future rate cuts.

While this may not be expected anytime soon, things can change quickly, especially if significant cracks begin to appear in the global economy. In such a scenario, returns on short-term cash and equivalents could quickly evaporate, highlighting some of the risk in over-allocating into these asset classes.

Of course, in a severe economic downturn, any significant deterioration in a corporate issuer’s financial position can also lead to losses, but our view is that investing in specific high-quality companies will help to reduce this risk, while still receiving attractive returns.