Matthew Wacher (left) and Ron Mehmet

Lonsec senior investment consultant Ron Mehmet likened himself to a rescue worker last year as he helped financial planners give advice to their fixed income investor clients when performances slumped.

“I felt like I was wearing the SES helmet for fixed income because there were a lot of planners ringing up saying: ‘I’ve got most of my most conservative customers in fixed income [and] we’ve never expected an absolute negative return. Why is fixed income producing minus 10 per cent at the moment? We’ve never seen this before’,’’ he tells Professional Planner.

A 35-year industry veteran, Mehmet had seen fixed income in negative territory before, in 2008 and 1994, showing a cycle of negative returns for fixed income cycling roughly every 14 years.

While 2022 was a larger performance slump than previously, Mehmet’s advice to investors was to sit tight.

“We tell advisors and financial planners that you stick to your customer’s five-year plan,’’ he says.

“You only lose money if you actually do a redemption from the fund. If you leave it there, more than likely your bond or your fixed income security matures. [Fund managers] roll it over and you’re going to get a higher running yield and more capital going forward.”

He adds when central banks begin to cut rates back to target ranges after they have tamed inflation, fixed income yields will go down and the prices of fixed income go up, giving investors a capital gain.

Active managers in fixed income markets would ensure the best performance when the Reserve Bank returned to tightening, Mehmet says.

“In this type of environment going forward, you need to have an active portfolio with a five-year outlook, and you need to be diversified,’’ he says.

“The key is diversified so you need to have some fixed and you need to have some floating, just like a person who has a home loan might do a cocktail will be fixed and floating.

While rates are rising, Mehmet says floating-rate strategies are needed.

“Which is great because portfolio managers of floating-rate funds want rates to go higher so they can give a higher-running yield or distribution to the clients every month or every quarter,” Mehmet says.

“But you also need the fixed-rate ones which might be showing a three-year capital loss because once the economy turns and the RBA goes from hiking back to cutting again, they’re going to make some decent capital gains.”

By allowing fund managers at the coalface to make those decisions, they can move quickly as the market can move 20 basis points in a day when it changes, he adds.

Morningstar Asia Pacific chief investment officer Matt Wacher says while clients and retirees were shellshocked by fixed income performances last year, most of his were in defensive positions which held cash.

“We did very well last year on the back of having very little bonds and very little duration, whether it be in the equity markets in terms of big tech stocks and things like that, or bonds [because it] gave us a real opportunity to rotate towards that as they became all of that became more attractive,” he says.

Now interest rates are rising, multi-asset portfolio fund managers are allocating much more to fixed income, he adds.

“The key areas for us in those markets, we’ve kind of seen the shorter end of the curve,” he says. “It’s the place where we’ve been where we’re more constructive in terms of our expected returns.”

He liked emerging market debt, some investment-grade credit and Australian bonds over international bonds, which gave investors a better risk to reward.

“In terms of government bonds, we don’t think anything is still a screaming buy,’’ he says.

“If there is another inflation shock… interest rates are going to rise. But we think that the income that you can earn on those government bonds and particularly Australian government bonds for Australian investors, starts to pay for some of the capital losses that people might endure if interest rates were to backup further.”

Bonds would give investors diversification benefits if some recessionary-type scenarios played out while they could generate more if they moved to riskier fixed income in emerging market debt, leveraged loans in the US or private debt in Australia, he says.

“We think that you’re going to get some benefit from bonds,’’ Wacher says. “You might lose a bit, if interest rates do continue to go up, but that’s potentially going to be because the economy is still growing.”

This translated to a defensive retiree portfolio would be comfortable holding a big chunk of its fixed income allocation in government bonds, both Australian and international, he says.

“You’d still have a little bit of cash but I think that you can pretty much deploy most of the defensive component into fixed income-type assets,’’ he says.

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