Shortening fixed-term durations in a move to protect clients from inflation is not the answer, says Charles McKenzie CIO fixed income at Fidelity International.
Mr McKenzie believes such an approach works against the client as significantly shortening duration results in a sizable proportion of income being sacrificed, as longer-dated bonds have a higher yield.
Also, shorter durations lead to higher and more positive correlation between the fixed income and equities components of a portfolio.
Mr McKenzie said: “As bonds are typically held to act as a good diversifier from the equity markets, you can therefore miss out on the diversification benefit if you reduce duration by too much."
Rather than fall back on shorter dates, Mr McKenzie proposes a different tack to managing a client’s portfolio.
He advocates broadening the scope of investment beyond the domestic market to take advantage of longer-term opportunities in overseas markets, such as the US and Australia.
Looking outside government bonds is also recommended, as according to Mr McKenzie there is no shortage of opportunities to attract the attention. Mr McKenzie said: “Our research suggests that currently investors get adequately compensated in terms of extra spread for the credit and default risk they are taking on by investing in corporate bonds. In particular investment grade bonds represent the sweet spot at the moment.”
Fidelity’s head of fixed income also suggests investors consider inflation-linked bonds as part of a diverse portfolio. He believes these options would offer some protection against further inflation hikes.
Patrick Connolly, a certified financial planner at Chase deVere, said: “It would be a mistake to move away from fixed income because of inflation.
"Yes, it has risen, partly because of the weak pound and rising energy costs, but that will work its way out of the system in time. Inflation is more likely to settle at around 2 per cent to 3 per cent and investors should look to beat that over time.
“We incorporate fixed income across our products and will continue to do so, as it offers security, diversity and a consistent stream of income.”
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