Sara Silano: “Say yes to bonds” was one of the key calls in the Morningstar Investment Management’s outlook for this year. But are bonds good for income investors? Nicolo Bragazza, Associate Portfolio Manager at Morningstar Investment Management, joined us to share his insights.
Nicolo, welcome and thank you for accepting our invite.
Nicolo Bragazza: Thank you for having me. So, after the significant rise in yields over the last couple of years, bonds are now offering more attractive yields and therefore they can now play again multiple roles in investor portfolios from diversification to yields. Bonds represent the bulk of the portfolio of any income investor, as income is contractually predetermined and paid at predetermined days. And if those bonds are government bonds, the likelihood of being paid back is higher. However, as a general rule, investors need to remember that the higher the yield and the income, the higher the risk. And it’s very important to pay attention to valuation, especially in periods where credit spreads are particularly tight.
Silano: What will happen to investors in treasury bonds if the ECB cuts interest rates in June?
Bragazza: As a general rule, lower yields imply higher bond prices. And this is because future cash flows are discounted at the lower yield and therefore their value goes up. However, the extent to which a cut will move bond prices does not depend only on the size of the rate cut but also by how much that rate cut is already priced in by the market. As of today, it seems that the market is already pricing a rate cut and therefore the move is likely to be less pronounced than if you were to get a completely unexpected cut. That said, this cut is not certain and therefore you can expect to have some positive impact on bonds if the central bank goes ahead with the rate cut.
Silano: What are the best options for income investors in the fixed income space?
Bragazza: So, the first thing that an income investor should determine is its willingness and ability to bear risk. A low-risk income investor can think of a portfolio of government bonds as a good option to get some predetermined income with low risk of not being paid back. However, if an investor has more tolerance for risk, an income portfolio should also include some corporate bonds and high yield bonds as structural components because they allow to generate extra yield. A more sophisticated income investor instead with tolerance for risk can also consider the addition of EM bonds to their portfolios, both in US dollars and in local currency, taking into account the extra risk coming from currency when we talk about local currency bonds.
Silano: Nicolo, thank you very much for coming here today. For Morningstar, I’m Sara Silano.
