Allba Asset Management’s Oscarsson warns on rates threat to bonds
Joakim Oscarsson, chief executive and manager at the family owned Swedish boutique Allba Asset Management, has picked up the theme of interest rates and the threat to fixed income investors, with a look back at the yield peak some three decades ago.
Oscarsson said in his latest monthly comment to investors that yields on Aaa rated corporate bonds hit 15.5% in September 1981, and that they have since steadily fallen to their current record lows – as compared over the past century.
But he warns: “This trend cannot of course last forever, and investors in bonds today must fight with the fear of rising interest rates.”
“Because bonds that are already owned fall in value when interest rates rise, many are wondering how risky it is to be invested in bonds if rates rise.”
The challenge lies in the inverse correlation between the price of bonds and their yield – if one goes up the other is going down. The problem facing investors is that in the current low interest rate environment, the chance of making money from falling interest rates is very small – they are already at historic lows – which instead leads investors to focus on the question how much could they lose if interest rates rise, and in that case, how long would it take to repair the losses.
History is the guide here, Oscarsson said. If interest rates rise sharply then it will create deep holes that take years to recover from. However, a longer but shallower rise could create even longer periods of zero return on the investor’s capital.
Above all, for those already invested via the secondary market in bonds today, if interest rates rise then coupons will remain low in absolute terms, and the improved coupons from acquiring additional bonds in a higher interest rate environment will only marginally improve the amount of time it takes to recover the loss of value.
Oscarsson said he sees no immediate risk of an interest rate rise in the near term, but likewise says it is clear there is no room for significant interest rate cuts – something that investors need to consider.