The fixed income balancing act

Investing in fixed income during times of market volatility carries two distinct risks, one of which could create attractive long-term investment opportunities, according to PutnamAustralia.

The investment manager’s head of institutional business, Dr Charles Wall, said investors needed to consider both credit and liquidity risk when approaching fixed income.

“Credit or default risk is where a security misses a coupon or principal payment and records a permanent loss in value,” he explained.

“As the fears of recession grow and the likelihood of higher default rates increase, more credit risk is being priced into the market.

“Given where we are in the economic cycle, investor nervousness about credit risk is likely to continue for some time.

“Liquidity risk, on the other hand, is where a security is temporarily mispriced because of a mismatch of buyers and sellers.

“As excess leverage is unwound across global fixed income markets, many high quality securities have moved away from their fundamental value.

“However, unless investors are forced to sell now, this risk does not reflect a permanent loss in value.”

Dr Wall added that the short-term mispricing of liquidity risk could create longer-term investment opportunities, citing the commercial mortgage-backed sector (CMBS) as one such opportunity.

“The CMBS sector is one example of a number of attractive high quality investment opportunities, both in terms of yield and an eventual recovery in liquidity related spreads,” he said.

“In some cases these are the best opportunities seen in over 10 or 20 years.”