Following the sharp reset in interest rates over the past year, investors are looking afresh at bonds given the higher yields on offer today from the asset class. In fact, yields on global investment grade corporate bonds are hovering around the highest they have been since 2009 (see Figure 1).

Rewind the clock back and for much of the past decade an investor would have had to do at least one of the following three actions to achieve a yield around today’s levels of close to 5%:

• Take on more duration risk (interest rate sensitivity) by investing in bonds with long maturities.
• Accept lower credit quality by investing in sub-investment grade bonds and therefore be more exposed to bonds that might potentially default.
• Take on emerging market risk by investing in bonds from outside developed markets.

That is not to say those would have been bad decisions – in fact, each of those actions would have offered opportunities as well as risks. What stands out today, however, is an opportunity to capture a high level of income for relatively low risk by investing in predominantly investment grade bonds.

What is particularly exciting about today’s bond market is that the front end of the yield curve is offering historically high yields. Today, investors can capture most of the yield available within global corporate bonds without having to stretch to long maturities; practically all the yield can be achieved with shorter dated bonds (1-5 years) as shown in Figure 2.

A change in direction?

But these attractive yields at the shorter end may not be around for long. Central banks have been on a mission to drive down inflation by raising interest rates and they are beginning to see some success with headline consumer price index (CPI) inflation dropping from a high reached in 2022 of 9.1% in the US to 3.2% today and in the eurozone from 10.6% to 5.3% today.¹ Interest rate futures markets are suggesting that we are approaching the peak in the US rate hiking cycle and that cuts could start within the next 12 months, particularly if the economy slows.² Rising rate environments typically result in a cooling economy and subsequent rate cuts to boost economic activity. There is a risk, however, that the markets might be wrong and interest rates and bond yields might rise from here.

Short-term government bond yields are heavily influenced by central bank policy rates so yields on these bonds are likely to fall if interest rates and inflation head lower. In fact, the market tends to move in advance of policy decisions. Corporate bonds typically offer a credit spread (additional yield over a government bond of the same maturity) to help compensate for potential credit risk. If the economy weakens this could send credit spreads wider but yields on investment grade corporate bonds tend to have a strong relationship with directional moves in government bonds. If yields on government bonds start to decline in the coming year, higher quality corporate bond yields could head lower as well.

Investors could seek to lock in today’s yield by buying an individual bond, but we think that a fixed maturity bond fund would be a less risky route. Just like an individual bond it has a regular coupon and fixed maturity date but comes with the added benefit of diversification across a portfolio of bonds. Furthermore, credit selection is undertaken by a team of experts, who will monitor the portfolio throughout its fixed term, helping to avoid default risk and maximise the yield.

Taken together, investors have, in our view, a window of opportunity to lock in a historically high yield. And a fixed maturity bond fund offers a straightforward investment vehicle to achieve this.

¹Source: Bloomberg, US Consumer Price Index, all items, urban consumer, year-on-year change, high at June 2023 and most recent figure at July 2023. Eurozone harmonised index of consumer prices, year-on-year change, high at October 2022 and most recent figure for August 2023. Correct as at 31 August 2023.
²Source: Bloomberg, US interest rate projections. Correct as at 31 August 2023. There is no guarantee that past trends will continue or forecasts will be realised.