Take the high road with high yield

Asia fix

Will inflation Trump fixed income?

Trump’s victory is likely to spell a period of higher and stickier inflation. Inflation-linked bond ETFs have seen consistent outflows following record inflows in 2021. Could the election result be a turning point that ushers in the return of US Treasury Inflation-Protected Securities (TIPS) in investor portfolios?

Since September’s Fed cut, the sharp back up in yields has been driven by both a rise in real rates as well as expectations of inflation, with the 10-year breakeven inflation contributing 22bps of the 58bps rise in 10-year US Treasury yields (Figure 1). A Trump win opens the door for elevated budget deficits, tougher trade policy and a crackdown on immigration – factors that will likely push inflation higher-for-longer and leaving the Fed less room to cut rates. For investors, owning some inflation protection through TIPS can act as an “election resilient” trade, which have outperformed nominal treasuries this year despite a having longer duration.

Notably, October saw a rotation out of core TIPS exposure into short duration TIPS (Figure 2). For investors looking to step out of cash without going too far, short duration TIPS could offer a balance in managing interest rate risk and protecting against higher-than-expected inflation.

A refresher on TIPS

TIPS are inflation-linked government bonds where coupon payments increase and decrease with changes in official inflation rates. This is done by adjusting the principal based on an inflation index, while fixing the coupon rate. As the size of principal is adjusted, the coupon amount will also change with changes in CPI. TIPS are thus able to offer some protection against the risk of higherthan-expected inflation. TIPS ETFs pay out the earned income of the portfolio, which primarily consists of the accrued coupon income and an inflation adjustment based on month-on-month changes in inflation.

No Time to Yield

A case for putting cash to work with bond ETFs

Last year, our whitepaper “The Great Yield Reset” discussed the generational opportunity for investors to rethink their portfolios with a greater focus on fixed income.

In our latest paper “No Time to Yield”, we highlight our updated expectation that global bond ETFs will reach US$6 trillion in AUM by 2030. We discuss the opportunity within bonds and why investors may want to consider moving now to capture decades high yields, get cash off the sidelines, and employ efficient, precise tools such as bond ETFs in this new market regime.

As investors take a more dynamic approach to asset allocation, we believe bond ETFs are among the most powerful tools within the investor tool kit to navigate this market environment.

The timing of potential interest rate cuts may be uneven worldwide, but the message is clear: Don’t wait.

Source: BlackRock, “No Time to Yield”, as of April 2024. There is no guarantee that any forecasts made will come to pass.

Key themes we discuss in this piece:

1. Time to put cash to work and capture higher rates Yields are higher today than they have been in years. If inflation indicators continue to fall, the time of elevated cash rates may be drawing to a close.
2. Investors are choosing bond ETFs in record numbers, but they have room to do more Many investors are still significantly underweight to fixed income, with a 22% average allocation, based on total global industry AUM, far below the “60/40” portfolio allocation often referenced in balanced portfolio discussions.
3. Now is the time to move Even with ongoing volatility in economic data and bond markets, we believe it’s time for investors to move because, historically, the market has tended to price in rate actions before they occur.

Index Your Bonds with Asia Credit

Asia bond markets definitely have a part to play in the next leg of growth in index and ETF adoption. As investors continue to move beyond the “active versus passive” debate, constant product innovation will offer increasingly precise sources of potential returns, and help lead more investors to embrace bond index building blocks alongside high conviction active strategies in pursuit of optimal portfolio outcomes.

In this Asia-focused “Index Your Bonds” paper, we spotlight iShares Asia Credit exposures, provide insights on how they are managed in practice, and discuss how innovations such as ESG integration will make indexing an integral part of investing in Asia fixed income.