The playbook for offensive-defensive investing as rates peak

As rates remain elevated, banks are offering attractive short-term fixed deposit rates. But the high interest rate environment will not be around infinitely. So, where could investors turn to for stable income when rates reverse course? Based on previous monetary tightening cycles and recent economic prints, BEA Union Investment believes the end of the rate hike cycle is near, and Asian Investment Grade Bonds are timely investment options. The asset class offers decent yields, has high credit ratings and has plenty of investment choices.

Following a slew of rate hikes for over a year, the Fed funds rate shot up to the current range of 5.25-5.5% from zero in the first quarter last year. Restrictive policies have brought the US' consumer price index down to 3.7% in August from 9.1% in June last year. Stripping out food and energy prices, core inflation is also on the downhill, tapering off to 4.3% in August. Albeit the levels are still some distance away from the central bank's 2% target, but the downtrend is confirmed. Inflation in other developed countries, including the euro zone and the UK, is also showing signs of slowing. As consumer prices fall, rates will eventually follow. At the time of this note, the odds for the Fed to raise rates in November are roughly 40%, with investors pricing in a rate cut of about 1% next year. Even if rates are to stay elevated for an extended period of time, they will reverse course sooner or later given softening inflation. With Asian Investment Bonds, one can lock in the yields now and capitalise on the opportunities from higher bond prices when rates retreat.

Asian Investment Grade Bonds, a defensive play with upside potential

Looking at Investment Grade Bonds, the yields they currently offer are pretty competitive to their High Yield counterparts, but with better credit ratings and stronger fundamentals, hence the relatively lower default risk. The breadth and depth of Investment Grade Bonds in Asia present generous opportunities for investors to pick good quality issuers, such as those with ample cash flow, low leverage and attractive valuations. Among them include South Korean financials and Indonesian power operators.

The current rates environment presents investment opportunities to play offence and defence

As global rates hover at high levels, bond issuers must offer attractive yields to woo investors, who would otherwise have opted for the risk-free options of bank deposits or US treasuries. Investing in bonds now has the benefit of locking in favourable yields at current levels. This edge will dissipate once rates start pulling back. That's why as the first step, it is critical to seize this opportunity in a timely manner.

As inflation cools, rates will also decline. Given interest rates and bond prices move in opposite directions, bonds that were bought early on in a high interest rate environment will now see prices go up because rates are falling. By then, investors might choose to sell the bonds if the premiums are lucrative, or choose to hold the papers until maturity for dividends. This offensive-defensive strategy offers investors the best of both worlds.

Rates are still lofty, but when they turn around, bank deposit rates will trend lower in tandem. Investors will then have to bear the risk of re-investment. Looking ahead is key. Otherwise, if one acts only when rates turn around, the ship might already have sailed.

Asian Fixed Income Investment Series

Asian Strategic Bond Fund Asia Impact Bond Fund
Invest mainly in Asian Investment Grade Bonds, with flexible allocation to High Yield Bonds as strategy play, to seek stable dividend and capital appreciation opportunities.
Thematic strategy fuses with 'Green, Social and Sustainable' bonds, it leverages the advantages of quality bonds in Asia.