Stuart Dear

Fixed income is set to be a standout asset class in 2023, both in absolute terms and relative to other assets, according to Schroders Australia head of fixed income, Stuart Dear.

However Mr Dear says the market environment is likely to stay volatile as the battle between slowing growth and still-too-high inflation plays out.

“Although the surge of inflation in 2022 rose to levels not seen since the early 1980s, with the resulting negative impact on the bond market, there is now reason to be optimistic about the outlook for the fixed income asset class,” he says.

“As well as the material possibility of high quality fixed income delivering strong returns this year, partly erasing last year’s losses, it should also be a good diversifier as we enter the down phase of the cycle. Riskier assets appear to be still priced for relatively benign macro outcomes.

“The fact that yields have repriced sharply higher means that forward-looking returns from bonds are now significantly better. For now, the income is back in fixed income.”

Mr Dear says determining value in government bonds is a fine art, as value depends on many moving parts including future economic growth, inflation, central bank policy, investor risk appetite, and market liquidity.

“Two of the most common bond valuation methods are estimating the ‘fair value’ level of bond yields given medium-term macroeconomic inputs, and comparing bonds to equities and making a relative assessment.

“Using both of these methods, bonds are ‘cheap’ at their current levels.”

“There is no question that high quality bonds now offer attractive absolute and relative value, and a compelling medium-term risk-adjusted return,” Mr Dear says.

Schroders Australia portfolio manager for fixed income and multi-asset, Mihkel Kase, agrees the next few months could potentially be a sweet spot for fixed income as yields in investment grade debt have already risen, prior to any economic slowdown.

“We still expect a period of volatility ahead in fixed income markets but we believe the rebuilding of yields across most investments means that these markets will be able to deliver income and expected improved returns to investors.”

“Bonds tend to do best when growth is falling, inflation is softening, and central banks are easing policy. While we may not see all three in 2023, Schroders believes at least two out of three are likely.”

Mr Kase says investors may be enticed to use the next few months to accumulate high quality assets at good levels and wait for better opportunities in risker assets.

“Although eventually the downside risks to growth are likely to dominate market pricing, these may not eventuate for some time,” he explains.

“Investors should consider taking advantage of attractively priced fixed income markets over the next few months as opportunities present.”

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Mihkel Kase

Schroders has launched an active fixed income exchange traded fund (ETF) on Chi-X Australia (Exchange code: PAYS) with the aim of helping investors strengthen the defensive allocation within their portfolios by boosting income, while seeking to protect capital.

PAYS delivers exposure to the Schroder Absolute Return Income Fund, which has a track record of meeting investors’ needs for reliable monthly income. It is managed by Schroders’ Australian Fixed Income team, backed by a global network of specialists based in 12 locations around the world.

Lead portfolio manager, Mihkel Kase, said that with interest rates at all-time lows, investors need to look further afield to find income.

“PAYS aims to meet this need while at the same time providing peace of mind that there is a strong focus on managing risk, should markets fall.

“Many of the options that offer higher yield for investors – including hybrids and leveraged loans – also increase the risk of capital loss – potentially more than investors realise. PAYS can complement these types of investments by reducing overall portfolio risk, which is particularly important now, as we enter the late stage of the investment cycle.

“In addition, PAYS is designed to supplement investments such as term deposits, providing reliable monthly income, currently 3.4 per cent per annum (post-fees). It also gives investors the flexibility to access their money if they need to.”

Mr Kase added that taking an active management approach is key.

“In an environment where interest rates are heading towards zero around the world, it’s important to be ‘active’ to have the best opportunity of finding the ‘winners’ and avoiding the ‘losers’.”

Mr Kase has been managing the underlying fund in which PAYS invests, the Schroder Absolute Return Income Fund, since it was established in June 2002. It has delivered a total return of 3.78 per cent over 3 years (post-fees) and is currently paying a monthly income of 3.4 per cent per year (post-fees). The fund has management fees of 0.54 basis points and is easy to access via one trade on the Chi-X Fund market.

Mr Vic Jokovic, CEO of Chi-X Australia, says the launch of PAYS increases the number of active ETFs that are exclusively traded on the Chi-X Funds market.

“We launched Chi-X Funds to help support further access, competition and innovation in the Australian marketplace.  We are delighted to be partnering with a quality top-tier global manager like Schroders, and to offer PAYS as part of our growing suite of funds.

“PAYS adds to the total number of funds traded on Chi-X, which offers trading in all Australian ETFs.

“Almost 40 per cent of trading volumes in Australian ETFs already takes place on Chi-X and the establishment of Chi-X Funds will further strengthen our significant volumes” Mr Jokovic said.

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