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Cover story – Fixed income


FIXED INCOME: IT’S NOT ABOUT THE MONEY


Warren Buffett says that fixed income has become bad news, but, as Andrew Holt discovers, for institutional investors there is more to bonds than income.


Fixed income is being labelled as the bleak midwinter option for institutional investors. The key culprit in the demonisation of the asset class is legendary US investor Warren Buffett. At the end of February, the chair and chief executive of Berkshire Hathaway warned in his annual letter to shareholders that fixed-income investors worldwide face a bleak future. The Sage of Omaha noted that the income available from a 10-year US treasury bond at the end of 2020 was 0.93%, 94% lower than the 15.8% yield available back in the heady days of September 1981. “Fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future,” Buffett said. Yet asset owners with considerable liabilities, such as pension funds and insurers, value fixed income as an asset class because of the defined returns such assets offer. “This statement [by Buffett] implies an environment of steadily rising rates which will erode the value of existing holdings of


18 | portfolio institutional | April 2021 | issue 102


bonds,” says Mark Hedges, Nationwide Pension Fund’s chief investment officer. “So yes, in such an environment values of exiting fixed income holdings decline.” However, Buffet has overlooked the key crux in his analysis, Hedges believes. “Pension fund liabilities also fall as rates rise as they suffer larger discounts,” he says. “Fundamentally, for a pension fund, much of the holdings of gilts and linkers are not bought for their investment returns, they are primarily about managing liability risks.” However, Ben Shaw, director at financing platform HNW Lending, believes that other elements of Buffet’s assessment are worth exploring. “The Sage of Omaha indeed has a point in that there are real prospects for inflation in the economy and so those investing in long-term fixed debt may well see not only very modest interest income but also a decline in the real value of their capital,” he says.


There is no doubt that the spectre of inflation is causing unease and eats into real bond returns. “Inflation would erode fixed


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