Why Some Fixed Interest May Still Make Sense, in Fisher Investments UK’s View

Globally, corporate and sovereign debt securities’ yields are historically low—even negative in some countries—hurting fixed interest returns.[i] Furthermore, Fisher Investments UK finds many financial commentators warn those rates are about to rise, and, since yields and debt security prices move inversely, that means investors get little yield for taking the risk of declining prices. That has many commentators in publications we follow asking: Why hold them at all? In our view, fixed interest’s primary purpose in portfolios is to dampen portfolio volatility to mitigate swings for those needing to draw cash flow. Yes, yields today are miniscule in most of the developed world, but we think fixed interest’s ability to cushion against short-term volatility endures—and makes a compelling case for them, should your goals, needs and/or risk tolerance make smaller swings optimal.

In Fisher Investments UK’s experience, many think fixed interest’s chief role is to generate interest payments investors can use to fund needed cash flow. But we think this misses a real—and important—benefit: Their prices tend to fluctuate less than equities in the short term—a vitally important point we think these investors should weigh.[ii] For an investor whose long-term financial goals require a relatively high rate of cash flow, a blend of equities and fixed interest can be very beneficial. Yes, portfolio income—interest or dividends—can help fund withdrawals. But it isn’t the only way to fund them. Selling slices of securities periodically can do so as well, and Fisher Investments UK finds it is often a better way to do it.

However, equity returns can vary greatly in the short term. Consider: The highest and lowest rolling 12-month returns from a global equity portfolio since 1950 are 67.1% and -46.8%, respectively (in US dollars).[iii] Over the same span, a portfolio invested entirely in global government debt experienced a high return of 38.4% and a low of -16.5%.[iv] Similarly, over 1-month periods since 1950, global equities have posted a median return (up or down) of 2.4% versus fixed interest’s 0.93%.[v] Because fixed interest has smaller fluctuations over short periods, we consider it less volatile. This lower volatility means that blending in fixed interest can mitigate swings—and, therefore, the extent to which an investor selling to fund cash flow is doing so whilst negativity has greatly depressed the value of securities they own. This, in our view, is fixed interest securities’ chief role in portfolios.

Still, today many commentators we follow argue now is different, presuming record-low rates are an anomaly that must reverse quickly as the economy moves on from the pandemic and monetary authorities reverse their efforts to stimulate economic growth. This is true to an extent, but we think careful positioning can mitigate this risk, too. Fixed interest comes in different maturities—the time until the security is scheduled to expire and return investors’ cash. Generally speaking, our research shows longer-maturity debt is subject to bigger price declines if yields rise. So if you worry over rising rates, owning shorter-maturity fixed interest can be helpful.

Now, in Fisher Investments UK’s view, it isn’t clear big rate increases are around the corner. Our research shows interest rates are sensitive to expectations of inflation (broad-based price increases economywide). Whilst many countries have seen inflation upticks in 2021, we expect these to prove temporary, tied to stresses that pinched supply as economies around the world reopened at uneven paces. American inflation illustrates this point well, in our view. The US Consumer Price Index (CPI), a gauge of prices across the economy, jumped in the spring on both a year-over-year and month-over-month basis. It peaked at 5.4% y/y and 0.9% m/m in June.[vi] But year-over-year gauges were heavily distorted by extremely depressed 2020 prices serving as the calculation’s denominator. Sharp increases in used car, car rental, hotel and airfare prices, which we think stemmed from reopening, inflated monthly data, in our view. Those factors cooled in subsequent months, with CPI slowing to 0.3% m/m in August.[vii] Many European countries are seeing similar impacts, but at a lag due to the Continent’s later, and more gradual, reopening.

Even changes in monetary policy are unlikely to send rates spiking, in our view—especially short-term yields. Whilst monetary authorities may continue reducing the pace of asset purchases—and even cease them at some point altogether—this is widely watched and anticipated, according to our read of financial publications. We think this mitigates the potential market impact by reducing surprise potential. Furthermore, those purchases mostly impact longer-term rates, not the short-term ones that would impact shorter-maturity debt securities most. Those would be more affected by overnight interest rate hikes, policy changes that most monetary officials’ statements we have reviewed suggest aren’t nearby.

Overall, no, fixed interest returns don’t appear likely to be great, in our view. But fixed interest can still mitigate volatility, which Fisher Investments UK thinks can be very important to meeting many long-term investors’ anticipated funding needs.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarentees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world markets and international currency rates.

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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

[i] Source: FactSet, as of 22/09/2021. Statement based on prevailing 10-year sovereign yields for Germany, France, the Netherlands, Spain, Italy, Denmark, Norway, Sweden and Ireland, as well as the ICE BofA Euro Corporate 7–10 Year Index yield on 21/09/2021.

[ii] Source: Global Financial Data (GFD), as of 02/02/2021. Statement based on comparison of equity return based on GFD’s Developed World Total Return Index and fixed interest return based on GFD’s World Government Bond Total Return Index, 31/12/1949–31/12/2020. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

[iii] Source: Global Financial Data (GFD), as of 02/02/2021. Equity return based on GFD’s Developed World Total Return Index, 31/12/1949–31/12/2020. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

[iv] Source: Global Financial Data (GFD), as of 02/02/2021. Fixed interest return based on GFD’s World Government Bond Total Return Index, 31/12/1949–31/12/2020. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

[v] Source: Global Financial Data (GFD), as of 02/02/2021. Equity return based on GFD’s Developed World Total Return Index and fixed interest return based on GFD’s World Government Bond Total Return Index, 31/12/1949–31/12/2020. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

[vi] Source: Federal Reserve Bank of St. Louis, as of 22/09/2021.

[vii] Ibid.