After years of extremely low interest rates, fixed income investments have become an attractive asset class again. Jeroen van Herwaarden, Portfolio Manager of Triodos Euro Bond Impact Fund, explains why it is a good time to invest in fixed income and how investing for positive environmental or social change may contribute to lowering credit risk.
When global inflation started rising strongly in 2022 after the COVID-induced lockdowns, central banks were initially convinced this rise would be transitory in nature. When it became clear the rise was much more prolonged, with the war in Ukraine and second-round effects like wage increases leading to extra price pressures, global central banks embarked on an unprecedented monetary tightening path. The subsequent rate hikes pushed up both short- and long-term interest rates to their highest levels in a decade.
Yield-to-maturity on balanced investment-grade portfolio now above 3%
Now that the peak in inflation is behind us and, after two years of unprecedented tightening, most central banks have reached the end of the rate hike cycle, the smoke seems to have cleared. Inflation has been falling last year and can be expected to fall further towards the central banks’ target of around 2 percent. As a result, financial markets expect central banks to start cutting interest rates in the first half of this year. All things equal, euro-based bond investors are now rewarded a decent annual return of more than 3% on a balanced portfolio of investment-grade bonds with an average duration of five years. This return does not only compare attractively to cash returns like the interest on a savings account, but it also provides bond investors with a buffer against adverse interest rate developments going forward. An additional advantage of these higher interest rates is that bond investments may increasingly start taking on their traditional role in a balanced investment portfolio again: to provide protection in periods of unfavourable equity performance.
Possible additional return to bond holders on top of attractive interest rates
If inflation keeps falling and economic activity slows down further over the following months, bond holders may expect an extra return from declining long-term yields. In addition, if the main central banks indeed cut rates this year by the currently expected magnitude or more, falling short-term interest rates may further add to bond investors’ total returns. But even if current inflation proves sticky and rate cuts occur later than expected, bond investors can still make a solid return based on the current yield levels.
Deteriorating company fundamentals ask for defensive positioning
We expect credit spreads to widen in the first half of this year, as tighter monetary conditions will start hurting the profitability of debt-heavy companies. The expected environment of weakening company fundamentals and rising default rates asks for a defensive positioning in terms of credit risk. As a result of our prudent investment policy and the defensive positioning of the Triodos fixed income investment portfolios, credit risk is considerably lower in our funds compared to the reference index.
Impact strategy accounts for fully impact-related profile and lower credit risk
We invest for positive change, alongside a financial risk and return that are in line with the broader market. Inherent to our impact strategy, selected issuers have, besides generating positive impact, considerably lower sustainability risks compared to the overall market. In addition, we invest to a large extent in ‘use-of-proceeds bonds’, a type of impact bonds of which the proceeds are earmarked to finance eligible environmental and/or social projects. Use-of-proceeds bonds are a strong instrument to steer the investments towards more positive impact. The issuer of the bond, moreover, is obliged to report on the impact results. Impact bonds have therefore become an important asset in our bond portfolios, currently accounting for two thirds of our euro-denominated fixed income investments. The market for impact bonds has become more mature over the past years, with more and more corporate issuers entering the market. But as the market for impact bonds still consists to a large extend of green- and social bonds issued by large government-related issuers, our fixed income portfolios have by nature of their impact strategy a large allocation to higher-quality impact bonds, which means a lower exposure to spread volatility.
In conclusion: attractive yield and resilience
In current market circ*mstances, with higher bond yields, fixed income investments have become an attractive asset class again from a risk-return perspective. Apart from the attractive yield, bonds also offer resilience for adverse market developments in risk assets like equities. Impact bonds add additional value by generating positive impact and contributing to lowering overall credit risk through the higher average quality of the issuers.
Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.
Heading into 2024, bond investors were sitting pretty. Yields were near their highest levels in decades, offering attractive income. Meanwhile, the potential for a slowing economy and expectations for upwards of five interest rate cuts by the Fed offered potential profit from rising bond prices.
With interest rates as high as they've been for 16 years, but with many experts predicting they may fall in the coming months, it could be a good time to take advantage of fixed-rate bonds.
In general, prices rise as yields fall in fixed income. So, investing in higher-yielding fixed income today could capture yield with the potential for positive price performance should market yields continue to fall, tracking cash investment yields lower along with Fed rate cuts.
Fixed-income security types are appealing to investors who prefer conservative investing strategies. In addition to being virtually risk-free, they can be an effective investment portfolio strategy during a recession. They diversify your portfolio, and you are guaranteed to get a return on your investment.
Treasury securities are debt obligations you buy from the U.S. government. They're considered safe and stable investments since they're backed by the government. Treasury bills, notes, and bonds are three types of Treasury securities.
The United States 5 Years Government Bond Yield is expected to be 4.496% by the end of September 2024. It would mean an increase of 22.3 bp, if compared to last quotation (4.273%, last update 20 Jun 2024 2:15 GMT+0). Forecasts are calculated with a trend following algorithm.
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
Why Trust Us? As of June 2024, no banks are offering 7% interest rates on savings accounts. Two credit unions have high-interest checking accounts: Landmark Credit Union Premium Checking with 7.50% APY and OnPath Credit Union High Yield Checking with 7.00% APY.
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
This can provide greater certainty than other sources of income like, say, dividends from shares. You will also be paid your initial investment on maturity; even if interest rates fall, you are locked into a rate of interest until maturity.
“Yields are still attractive.” What's key for investors to remember is that “lower” is all relative. Bond market strategists and fund managers generally agree that yields are still attractive, especially relative to inflation, and will likely stay higher than before the pandemic.
Here are 3 reasons why now's a good time to evaluate the role of high-quality fixed income exposure in your portfolio. Bonds are providing healthier yields than we've seen since before the 2008 global financial crisis. Higher current yields support a much-improved outlook for bond returns going forward.
Fixed-income investing can be a good strategy for new investors who want stability and regular income. Bonds and other fixed-income assets offer reliable returns and can help manage risk, as they are less volatile than stocks.
When the RBI cuts rates, banks and NBFCs usually follow suit by lowering the fixed deposit interest rate. This means the attractive rates we're seeing now might not stick around for long. By investing in Fixed Deposits(FDs) now, you can lock in the higher interest rates before they potentially drop.
With this possibility in mind, the outlook for fixed income looks bright, especially given the relatively high starting point for bond yields. One only needs to look back a few years to see how much more yield bonds now offer investors.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
We believe that a good core portfolio needs to include equities, your growth engine, and fixed income, your stability, so it can serve as an anchor to meet your long-term goals.
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