Fixed income is seeing renewed interest among financial advisers after a period in the doldrums but with this new enthusiasm, advisers may be left wondering where to begin.
Viewed as complex by many advisers and with misconceptions rife, Mehmet says his first step is always to educate them and help them understand how vehicles can fit in within a portfolio.
“Some people think ‘it’s all too hard’ and stick with cash or term deposits but bonds can provide that ballast for when things change in equity markets. So I try to give people confidence to invest in bonds because they can provide that regular income and stability,” he said.
One of these fears stems from experiences during 2022 when they may have seen a negative return but Mehmet said this typically only occurs every 14 years, far less than many people may think.
“The theory is once every 10 years you get a negative return in bond funds, but in actual reality it’s actually every 14 years.
“Yes, there has been a negative return which has been a turn-off for some investors. But they’ve got to understand it only happens at times when the central banks are jacking up interest rates because they may have an inflation problem or there is some other issue that’s happened and they need to tighten monetary policy and it impacts bonds for a short period of time.
“Once the hiking is over, people pile into bonds because then bonds settle down, they come back down over time and you’re picking up a slow capital gain as well as that regular income.”
Another misconception stemmed from the difference between active and passive fixed income funds where Mehmet said active funds could outperform their counterparts, unlike equity versions, because they can invest in the better-quality bonds. As a result, around 75 per cent of active global bond managers had outperformed passive ones over the long term.
“Passive is replicating the index, you end up with a lower quality of the index because the active managers can go after the better bonds and avoid the ones that look pretty shaky.
“It’s a very different picture [to equity] because of the complexity and make-up of fixed income.”
Fund selection considerations
Putting all this into practice, Mehmet shared lessons from his research house experience to explain to advisers what they should consider for their client portfolios and the red flags to avoid in a fixed income fund.
This will heavily depend on the needs of the client and their outlook, whether they are an accumulator or in retirement and how comfortable they are with taking risks.
“This will determine whether they take a fund manager who is absolute return and one who is more benchmark-focused which takes into a broader range of instruments.
“If they are quite conservative, there are managers who compare themselves against the global benchmark or there are other managers who have a pretty high yield and can provide a very good buffer.”
When it comes to selecting a specific fund for their client portfolios, Mehmet said the biggest considerations for advisers should be around the track record and experience of the manager, particularly as ever-increasing numbers of new, less experienced managers enter to market.
“You should have a manager who has been through a number of interest rate cycles and has the experience and know what type of strategies to put in place to enhance returns for clients. Also that they have teams who are varied in their skillsets and knows what lever to pull and to avoid.
“A manager with a long track record and a big team would give me a lot of comfort as a core fixed income addition.”
Using an active manager also means they can react far quicker than a financial adviser to central bank or geopolitical actions and the adviser can relax knowing their allocation is being managed.
“These days, when there is volatility or a geopolitical event, it all happens within several weeks rather than months so if you allow the active manager to do the work for you then you can rest easy that they will take the appropriate action on the portfolio rather than you physically having to move that money.”
