Some investors may be holding off towards bond investment given the recent period of rapidly rising interest rates. Others may also be waiting for the Reserve Bank of Australia (RBA) and other central banks across the globe to finish hiking or even begin cutting interest rates before they raise their bond allocations.
However, Vanguard cautioned that investors who are trying to time the market with their re-entry into bond markets have the potential to miss out on higher yields.
“Waiting for the ‘right’ moment to review your bond exposure may mean missing out on a price boost when rate cuts do eventually happen. Moreover, it could mean missing out on the rate peak and enjoying higher yields,” the investment firm stated.
“For those entering the bond market now, this means there’s an opportunity to enjoy historically higher yields while potentially benefiting from short-term price tailwinds if rates do moderate.”
As such, the benefit to long-term investors of being invested in bonds is likely to outweigh the cost of being early if yields were to remain flat before the rate cuts hit.
PIMCO recently encouraged advisers to flag with clients asking about timing the market that the easing cycle is already underway, particularly with the European Central Bank, Bank of England and US Federal Reserve all expected to make rate cuts by the end of the year.
Vanguard continued: “Timing the market is often harder than we think, and getting timing decisions wrong can mean limiting your returns in the long run.”
Meanwhile, Robert Mead, head of Australia at PIMCO, said: “Many Australian investors are running equity-heavy portfolios with significant cash buffers in the form of term deposits. We believe that in this environment, investors should be considering how to build resilient portfolios and that bonds remains compelling.
“One of the most effective ways of mitigating market volatility is for investors to balance the growth assets in their portfolios with defensive assets such as bonds, which should bolster portfolios in a risk-off scenario when equities and other risk assets decline. Given the current environment of high interest rates and elevated equity market valuations, now is a particularly opportune time to diversify portfolios by adding core bonds.”
Moreover, the RBA’s latest decision to hold interest rates at 4.35 per cent for the sixth consecutive time has affirmed expectations that the hiking cycle will soon be coming to an end.
AMP’s chief economist Shane Oliver previously shared five reasons why he believes a cut is on the cards for the RBA, including restrictive monetary policy and high recession risks.
Mead added: “While the RBA has not ruled out rate hikes, we continue to believe that the next move will be a rate cut, given that core inflation appears to be easing and we expect further global volatility.”
As a result of this, the current rate environment is proving to be favourable for bond investment, which typically outperforms once rates have hit their peak.
Vanguard said: “Higher rates can bring benefits to those seeking long-term diversification with high-quality bonds by offering a stable source of relatively low risk income. Now that we’ve reached what appears to be the peak of interest rates, now is a great time to consider the benefits of bonds in your portfolio.”
The end of a hiking cycle has historically been associated with a peak in yields, proving to be good news for bonds.
For example, the Australian Composite Bond Index returned 8.4 per cent over one year and 6.7 per cent over three years following the 2009 rate hiking cycle. Meanwhile, the Bloomberg AusBond Bank Bill Index saw returns of 5 per cent over one year and 4.1 per cent over three years, according to Vanguard and Bloomberg data.
