Highlights

It is now possible to extract an attractive yield from a mix of high-quality government and corporate debt instruments that are relatively lower risk, as demonstrated in the below chart. Higher yields mean investors can move up the quality scale to meet their income requirements.

Still, it can be challenging when market conditions in developed market government bonds have tested nerves this year, reverberating across other fixed income and credit asset classes. While major developed central banks have paused on rates recently, the direction is uncertain and further hikes are possible. Inflationary pressure remains elevated due to long-term trends such as deglobalisation, decarbonisation and the desire to debase existing debt burdens. Recent geopolitical tensions and disappointing earnings also add to investor anxiety.

Click here to read the full article

Take cash strategies, which invest in very short-duration papers with little interest rate risk and are yielding about 5% in US-dollar as of October 31. If interest rates continue to rise or stay in a ‘higher for longer’ scenario, cash can be an attractive option for certain income-focused investors. In addition, these strategies can serve other purposes in portfolio allocation. For example, cash may be needed as a risk buffer or to take advantage of future opportunities if investors are expecting asset prices to become undervalued in a severe economic slump.

With market uncertainty rising, some are wondering whether to rely more heavily on cash strategies? If they are tempted, what are the risks? The answer is complex and depends on specific investor targets and constraints, in addition to their views on the path of interest rates (see below chart), inflation, and economic growth.

We believe a third scenario of a recession is most likely and may start as early as 2024. In this case, central banks may pause and eventually be forced to cut base interest rates to protect growth, and cash’s outperformance over longer-duration bonds may reverse for the following reasons:

• Money market funds (MMFs) and other short-maturity, low-risk debt strategies have outperformed many longer-duration bond categories as central banks have aggressively increased interest rates since March 2022. This is largely because these strategies are more adept at closely tracking policy interest rate hikes relative to longer-duration bonds. Just as they closely track interest rates up, so too on the way down.
• The outlook for interest rates is more skewed to the downside in the next 18 months compared to the previous 18 months. With MMFs, the associated reinvestment risk could make it more difficult to lock in higher rates relative to longer-duration bonds if interest rates are expected to fall.
• Real rates remain low or near zero in many major developed markets even as central banks have aggressively hiked. For some, MMFs and other low-risk income strategies may not suffice if higher real yields are required. Purchasing power will erode over time without capital growth, which is non-existent in cash strategies.

As a recession is delayed and peak interest rates are nearing, investors are increasingly pricing in a ‘higher for longer’ scenario. However, relying on any one scenario or market trend - such as MMFs in a ‘higher for longer’ interest rate environment - for income could leave them highly vulnerable.

Investors should closely monitor the interconnectivity of the return drivers in their income-focused strategies at a time when volatility and dispersion are rising. Taking a step back and reassessing the source of income in their portfolio now will pay off in the future, no matter which macro scenarios emerge.

Click here to learn more about optimising income and download the PDF

Important Information

This material is for Investment Professionals only, and NOT for distribution to general public or to be relied upon by private investors.

This material is provided for information purposes only and is intended only for the person or entity to which it is sent. It must not be reproduced or circulated to any other party without the prior permission of Fidelity.

This material does not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities in any jurisdiction or country where such distribution or offer is not authorised or would be contrary to local laws or regulations. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.

This communication is not directed at, and must not be acted on by persons inside the United States. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers. This material may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such Third-Party Content and does not explicitly or implicitly endorse or approve such content. Fidelity International is not responsible for any errors or omissions relating to specific information provided by third parties.

Fidelity International refers to the group of companies which form the global investment management organization that provides products and services in designated jurisdictions outside of North America. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances, other than when specifically stipulated by an appropriately authorised firm, in a formal communication with the client.

Europe: Issued by FIL Pensions Management (authorised and regulated by the Financial Conduct Authority in UK), FIL (Luxembourg) S.A. (authorised and supervised by the CSSF, Commission de Surveillance du Secteur Financier), FIL Gestion (authorised and supervised by the AMF (Autorité des Marchés Financiers) N°GP03-004, 21 Avenue Kléber, 75016 Paris) and FIL Investment Switzerland AG.

In Hong Kong, this material is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission.

FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. This document / advertisement has not been reviewed by the Monetary Authority of Singapore.

In Taiwan, Independently operated by Fidelity Securities Investment Trust Co. (Taiwan) Limited 11F, No.68, Zhongxiao East Road, Section 5, Taipei 110, Taiwan, R.O.C. Customer Service Number: 0800-00-9911

In Korea, this material is issued by FIL Asset Management (Korea) Limited. This material has not been reviewed by the Financial Supervisory Service, and is intended for the general information of institutional and professional investors only to which it is sent.

In China, Fidelity China refers to FIL Fund Management (China) Company Limited. Investment involves risks. Business separation mechanism is conducted between Fidelity China and the shareholders. The shareholders do not directly participate in investment and operation of fund property. Past performance is not a reliable indicator of future results, nor the guarantee for the performance of the portfolio managed by Fidelity China.

Issued in Japan, this material is prepared by FIL Investments (Japan) Limited (hereafter called “FIJ”) based on reliable data, but FIJ is not held liable for its accuracy or completeness. Information in this material is good for the date and time of preparation, and is subject to change without prior notice depending on the market environments and other conditions. All rights concerning this material except quotations are held by FIJ, and should by no means be used or copied partially or wholly for any purpose without permission. This material aims at providing information for your reference only but does not aim to recommend or solicit funds /securities.

For information purposes only. Neither FIL Limited nor any member within the Fidelity Group is licensed to carry out fund management activities in Brunei, Indonesia, Malaysia, Thailand and Philippines. 

GIM23UK1015