Most investors appreciate the role of fixed income in a diversified portfolio – steady income streams, lower volatility, and protection against falls in equity values during periods of market stress. However, by the end of June 2019 the Australian Government 10-year bond yield had fallen to an all-time low of 1.32 per cent. In the last two months the RBA cash rate has been lowered from 1.50 per cent to one per cent with many economists predicting further interest rate cuts to as low as 0.5 per cent.
The question often asked is whether an allocation to fixed income at such low yields is still worthwhile? To add to the conundrum, yields offered on international bonds are similarly at or near historic lows.
This article looks at a number of factors to consider when assessing whether allocating to fixed income in low-yielding environments still makes investment sense. In particular, we revisit the concept of yield to maturity (YTM) and look at the performance of fixed income over shorter timeframes, the role of diversification, and the risk of capital loss should yields rise.
YTM AND CHANGING EXPECTATIONS
Investors tend to focus on YTM as the single most accurate gauge of the future...