From the global financial crisis onwards, rates had been on a downward path, falling steadily from 7.2 per cent in June 2008 at the height of the crisis to just 0.1 per cent in 2022. This meant fixed income managers and analysts could get used to many years of positioning their portfolios for a low-rate environment.
But that changed in May 2022 when rates were finally hiked back up from 0.1 per cent to 0.35 per cent and have continued to rise since then by 400 bps to reach 4.35 per cent in March.
Money Management spoke with three younger investment professionals who began managing fixed income in the last decade to unpack their experiences with the current rate cycle.
For Cameron McCormack, portfolio manager at VanEck since 2020, his attraction to fixed income portfolio management stemmed from his actuarial and mathematical background.
“The intricate analysis required to assess bond yields, duration and credit risk perfectly aligns with my quantitative aptitude. Additionally, the challenge of optimising portfolios to achieve stable returns while navigating market volatility excites me,” he described.
Meanwhile, Jessica Ren, investment manager at Yarra Capital Management since 2023, transitioned her skills as a rates strategist at Westpac into management in the fixed income space.
“I joined the industry because I wanted a career path that could allow me to make decisions and have a direct impact on investment outcomes and performance, as I wanted to see my trade ideas come to fruition,” she said.
David Xu, credit research analyst at Antares Fixed Income since 2023, said he joined the world of fixed income from a credit risk background out of a desire to see his skills translated into direct investment decisions.
Differing expectations
The younger professionals noted how their experience working with fixed income so far differed from their initial expectations before joining the industry.
For Ren, her perceptions of what she would find in the investment world had been influenced by what she saw in Hollywood movies, but she found this was not the case.
“When I started in fixed income, I thought it would be like what I saw in Wall Street movies – big events driving huge profits or losses in a high-stress environment. But I quickly learnt it’s much more personal.
“Everyday events, from government policy decisions to my weekly grocery bill, play a huge role in how the market moves. It’s fascinating how the little things in my life connect to what happens in finance, which has shown me a side of the industry I would never have expected,” she reflected.
Meanwhile, McCormack didn’t anticipate to see such significant bond market volatility over the past five years.
He said: “The emergence of COVID-19 saw bond liquidity evaporate and subsequent rapid central bank rate hikes fuelled rates volatility.”
With interest rates being on an upwards trajectory from record lows of 0.10 per cent to 4.35 per cent, constant rate pauses or hikes have now become the norm for younger managers. Having handled rates moving upwards, that could all change again in a few months as central banks start to embark on a period of monetary easing to bring them back down again.
Observing and learning from her more experienced colleagues was crucial for Ren as she navigated her first rate cycle.
“This rate hike cycle has been unique because it emerged off the back of extraordinary conditions coming out of the pandemic, and unconventional monetary policy, so I definitely gained some valuable experience,” she said.
Xu said as well as his own colleagues, he learnt from watching how corporations handled the rate movements, especially those in interest-rate sensitive sectors.
“It has been interesting to see how corporates have managed the rate cycle, particularly those from interest-rate sensitive sectors, surprisingly most have done quite well in Australia.
“Going into the tightening cycle, we were short duration and maintained overweight exposures to floating rate credit securities. More recently, we have shifted towards more fixed rate credit exposure given the ability to lock in fixed yields of 5 per cent to 6 per cent by solid investment grade issuers. My focus as a credit analyst has been to identify issuers that would perform well in this environment compared to those that might underperform.”
Money Management also spoke with Kellie Wood, Schroders deputy head of fixed income, who has spent 17 years within the fixed income division at the investment firm, having joined from UBS in 2007.
Wood recognised the difficulties of younger fixed income professionals managing their first rate hiking cycle, describing the current period as “one of the toughest environments for investment decision-making”.
In the early stages of the hiking cycle, it was crucial to have a strong gauge on real-time data given the speed of the rate cycle and lags in monthly economic data, Wood added. Remaining disciplined in their investment approach through highly volatile markets has also been fundamental for younger managers.
She elaborated: “This cycle has been very different compared to what we have experienced over the last few decades. A number of distortions – whether it be relating to supply chains or fiscal support – and the general uncertainty around inflation has made this cycle more difficult to read.”
Comparing it to the GFC, she said managers nowadays have to navigate much more macro volatility and more variability around growth and inflation outcomes.
Investment outlook
The current environment has also seen investors’ appetite for fixed income increase substantially as they look to secure higher yields. For example, PIMCO believes the Australian bond market is already offering compelling yields to investors regardless of the next action of the Reserve Bank of Australia (RBA).
Looking ahead to the RBA’s next board meeting on 7 May, the four fixed income professionals are largely expectant of another cash rate hold for now. They underlined the next Q1 consumer price index (CPI) as being “pivotal” in shaping the RBA’s positioning.
“However, ultimately, I think the board will likely keep the cash rate on hold and reinforce a mild tightening bias similar to the March meeting. Labour market resilience and likelihood of upside inflation surprises rule out the chance of rate cuts before the end of this year,” McCormack said.
“I’m expecting the RBA to maintain the status quo, without much change to their language after shifting to a neutral stance from a tightening bias last month. Given the continued strength in the US economy, it will also be interesting to see if the RBA will address whether their policy decision is dependent on what happens globally,” Ren noted.
As for how this hiking path has affected bond returns, 2023 saw a successful return to outperformance for fixed income after negative returns in 2022.
Australian government bonds saw returns of 4.6 per cent in 2023 while inflation-linked securities returned 9.7 per cent and global high yield saw returns of 11.5 per cent.
“Global rates appear to have stabilised, which has attracted investors to return to fixed-rated assets as they are able to secure higher yields at levels not seen for the past 10 years. With broad expectations indicating an imminent decrease in interest rates, investors in fixed-rate assets stand to benefit from maintaining longer duration positions during a rate cutting cycle,” Ren said.
Wood concluded: “The restoring of valuations and higher yields now offers a strong buffer to any capital volatility or losses around interest rate moves. Fixed income is now in a position where it can deliver positive returns in a number of scenarios – a reflationary environment, soft landing or recession. This puts fixed income back in the box seat!”
