Bond investment big future theme

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Goldman Sachs recently launched an absolute return bond fund called the Global Strategic Bond Fund (GSBF). As he gives his tips to financial advisers, Goldman Sachs fixed income Asia head Philip Moffitt says given the current fed taper, bond investment will be a big theme for the future.

While there is still a viable role for fixed income in portfolios for the long term, right now we are in a situation where that role should be challenged, says Moffitt.

“We think global interest rates will start to rise as global banks come to the end of their very aggressive easing policies. Particularly the US Federal Reserve but we think most central banks will do so over the next 12 to 18 months.

“As they come to an end interest rates will normalise and rise and the prospects of capital losses in fixed income portfolios are high, particularly losses from duration risk. Owning a standard kind of fixed income portfolio exposure is an exposure we think right now has a very high probability of generating negative returns in a portfolio.”

Instead of starting with a long exposure to duration and credit risk, the GSBF starts with cash.

“It can be zero or negatively exposed to interest rates in periods when they are rising and negatively exposed to credit spreads in periods when they are expanding,” said Moffitt.

“It's designed to deliver similar returns to a normal fixed income investment in a good or a benign environment but provides protection in a difficult environment."

Moffitt predicts it is going to be impossible for the Australian fixed income market to resist the pressure of rising global rates, and the strength of the Australian dollar will cause the RBA to cut rates one more time.

“I think it's crystal clear that the RBA thinks the currency in the mid-90s is too high and is inhibiting the prospects for rebalancing the economy. That in turn is inhibiting the growth potential of the economy and they feel, and hope, the current policy settings will see the currency weaken,” he said.

“The greater influence from longer term bonds in Australia comes from what is happening in global markets rather than the cash rate and as rates rise particularly in the US that will drag long-term Australian bond yields higher. As a result sitting passively in an exposure will generate negative returns."

Moffitt thinks tapering will come in January or February, a few months earlier than the consensus view.

"Our view of the taper is that the Fed is probably going to try to disentangle the concept of taper from the concept of rising rates. One of the problems that emerged earlier this year when the anticipation of taper started was that the market couldn't distinguish between reductions in buying bonds and when rates were going to rise.

“You've seen subsequently the Fed repeatedly talking about the unemployment rate as a signal around rate rises, as well as tapering. We think they will try to unbundle those things and provide clearer sign posts for rate changes independent of tapering.”

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