Navigating fixed income investments during times of high inflation & rising interest rates
High levels of inflation and rising interest rates across global markets are presenting challenges for investors who look to fixed income investments to produce a steady stream of income. One strategy wholesale investors and high-net-worth individuals (HNWIs) can implement to offset these challenges is to invest in floating-rate (variable rate) investments such as private credit.
Understanding rising rates and inflationary pressures
On a global scale it is evident that central banks all have a common goal; to contain inflation. The Bank of England, the Bank of Canada and more recently the US Federal Reserve have all increased base rates to try and ease inflationary pressures. Closer to home the Reserve Bank of Australia has taken a more aggressive stance over the recent months, with multiple base rate increases as inflation continues to rise.
Rising inflation has two serious implications. For one, the bond bull market that has lasted for nearly forty years is likely over. However, at face value, this isn’t necessarily a bad thing for investors who are reliant on fixed income investments, as higher yields will likely result in better future returns. What it does mean though is that the positive disinflationary market characteristics are a thing of the past. The other implication of rising inflation is that bond-equity corrections could move back to positive which has historically been the case when inflation has been higher than 4% or 5%. Whilst this isn’t all bad news, it does mean that anyone reliant on regular income derived from fixed income investments should be rethinking the traditional 60/40 growth to defensive portfolio distribution.
Global markets are also witnessing a readjustment in the yield premiums on corporate bonds over government bonds due to central banks rising base rates and the sell-down of assets accumulated through their quantitative easing (QE) programs to remove liquidity from the broader market. Whilst the central banks may not directly sell the purchased bond, it is possible that they will take a more passive approach by not reinvesting the proceeds of maturing assets. In both instances, the central banks will still be withdrawing liquidity from public markets.
It is our belief that the anticipation of liquidity withdrawal has been driven by the concern over rising interest rates. If central banks over-tighten and become too aggressive in an effort to contain inflation it could in fact trigger a recession. A recession would drive credit spreads wider, increasing the likelihood of defaults, particularly from lower quality corporate credit. From our perspective, an imminent recession is less likely, but we do expect to see indicators of recession risk to rise in the near future.
What does this mean for HNWIs looking for a regular income?
Due to the rise in bond yields and wider corporate credit spreads, overall fixed income investments appear better value today on paper than they did several months ago. But the outlook certainly isn’t smooth sailing. We are sitting at only the beginning of the tightening cycle, with further rate increases expected and rising uncertainty on whether the increases will be able to contain inflation. For investors, it is important to take a proactive approach to ensure your portfolio is set up for strong returns in a challenging global market.
One approach to address some of the headwinds experienced in the public fixed income market is investing in private credit. As an alternative asset class, private credit is not actively traded and therefore has not experienced the wide market adjustments that public fixed income investments have. The second advantage of private credit is that the underlying pool of assets is generally less concentrated than publicly traded fixed income products. In an economic downturn, the diversity of credit assets offered by a private credit fund will perform better than a single asset, highly concentrated pool of fixed income, for example, a government issued bond.
At Remara, our Private Credit Fund is built upon a pool of actively managed, highly diversified loans across businesses, corporates and real estate exposures. The diversity of the loan pool allows our investment specialists to manage the tenure and liquidity of the loan portfolio, limiting single concentrations. As a result, the fund performs better than market average returns in the type of dislocated markets currently being faced. Investors in our Private Credit Income Fund have received a return of 13.40% p.a. over the past 12 months (post fees), with distributions paid monthly.
To find out more about our Private Credit fund and how it can diversify your portfolio concentration to mitigate rising inflationary pressures, contact our team today.
