Inflation and rising interest rates present challenges for fixed income investors because they tend to lead to lower prices and falls in the real value of returns. With this in mind, the following are strategies that investors can consider to safeguard their portfolios over the coming months.
1. Favour asset classes such as high-yield corporates, which have tended to do well in higher inflationary environments
High yield is a growth-sensitive asset class, which should continue to benefit from a still positive global growth backdrop. High-yield bonds have typically done particularly well during the recovery phase of the business cycle as default rates fall. They have also done well during the later stages until default rates start to rise again.
2. Diversify in countries with different inflation dynamics
Emerging market (EM) local bonds are attractive, offering value after 2021's aggressive rate hikes. EM reflation is more controlled than in the US and there is no stimulus hangover. EM central banks hiked decisively ahead of the US Federal Reserve (Fed), and fiscal policy is normalising. EM inflation may peak in 2022, especially since EM policymakers have a track record in managing cost pressures.
3. US TIPS offer select opportunities as an inflation hedge, though valuations are less compelling after 2021's strong rally
US Treasury Inflation-Protected Securities (TIPS) may offer some value focusing on shorter maturities. Front-end TIPS should continue to be supported by high realised Consumer Price Index (CPI) as carry matters more for front-end TIPS.
For more on the implications of the current inflationary environment, take a look at Inflation: Navigating a Resurgent Challenge, a content hub brought to you by Investment Week, Professional Adviser and Capital Group
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. The information provided is not intended to be comprehensive or to provide advice. Emerging markets are volatile and may suffer from liquidity problems.
