If a year could come stamped with a health warning – or, better still, a wealth warning – then 2013 should carry one. Of course, many would say that this applies to bond markets, but it equally applies across a number of risk asset classes that produced stellar returns towards the end of 2012.
We see a potential risk this year for investors, especially those in or close to retirement, who may be forced to look for new sources of yield in a low-interest-rate environment.
How seriously you view this risk depends, of course, on your outlook for interest rates. A number of commentators argue that global government bond yields are unsustainably low and at risk of spiking upwards sooner rather than later. If they are right, then fixed-income investors should delay entering or increasing their allocation to these bond markets until interest rates begin to rise again.
While I agree that government yields are unsustainably low in the medium term, I see limited near-term risk of a rise in interest rates. The signs of cyclical recovery in the US are too weak and the structural impediments to global growth (such as fiscal austerity and sovereign debt in Europe) too great for interest rates to rise soon.
On the contrary, we see a select number of attractive opportunities in domestic and international debt securities. And even in the event of a rising interest rate environment, there are methods of managing this risk; for example, investors could consider investing in floating rate notes that regularly reset as rates rise or fall.
Something more compelling?
Of more immediate relevance to Australian investors, the outlook for official interest rates for the foreseeable future is that they will continue to fall from the current 3 per cent as the Reserve Bank of Australia steers the economy through the effects of a high Australian dollar and declining resources boom.
There is a risk that Australian investors who may have been invested for some time in long-term deposits earning 7 or 8 per cent will receive a nasty shock as these deposits roll off and they find current market offerings are yielding little better than 4 per cent. They and their advisers will naturally look for something more compelling.
What they should remember, however, is that high-yielding investments by their nature are relatively high risk; and, in a low-interest-rate environment, the risks may be higher than they would be during “normal” market conditions. Beware, therefore, of new investment products structured to yield 8 per cent or 9 per cent – they might be too good to be true.
Do the sums again
We believe that rather than simply reacting to low term-deposit rates by chasing yield elsewhere, advisers and their clients should step back and reassess their investment objectives on the assumption that rates will stay low for some time. For many, the conclusions will be stark.
Those still working and contemplating retirement, for example, may need to redo their sums and plan to work and save longer to increase the size of their nest egg. Those already in retirement may have to cut spending or accept more risk (in the hope of more reward) in their portfolios.
Our general view on bond markets, unrelated to individual investors’ risk-reward profiles, is that they continue to offer attractive opportunities for strategies that are actively managed and diversified. Such strategies are likely to include bonds in countries such as Australia and many of the emerging markets, where interest rates may continue to fall.
Peter Dorrian is head of global wealth management at PIMCO Australia.
