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Long duration assets can play ‘important role’ in portfolios

To protect returns against the volatility expected in the months ahead

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With US yields above 3% and more Federal Reserve interest rate rises predicted, Fidelity’s fixed income team is backing long duration assets to play an important role in investor’s portfolios.

While the Fed delivering its most aggressive move in 22 years in its May Federal Open Market Committee meeting, Steve Ellis, global chief investment officer of fixed income at Fidelity International, said policymakers are still firmly playing catch-up as they look to combat runaway inflation.

“Central bank rhetoric and actions remain the key driver for markets as they look to balance the tightening path without creating an accidental recession,” he said. “In hindsight, the Fed committed a policy mistake last year by letting inflation run out of control, and as a result, it could be walking a narrow road for some time.”

Given the Fed’s history in rarely been able to engineer soft economic landings, Ellis said the risking forward is financial conditions tighten aggressively to the point the market narrative will soon shift from inflation to recession.

“This scenario is not currently discounted in asset prices,” he said. “Indeed, our own in-house aggregate recession model suggests just under 15% probability within the next two quarters.”

Risky assets

Should the tide turn, Ellis argued risky assets would have to reprice “quite significantly” from here.

“Credit spreads would not be immune, and we are defensively positioned,” he said. “On a relative basis, however, we do see value, and a reasonable amount of risk premium, priced into areas such as investment grade assets, with all-in yields that look quite attractive now.”

On the flip side, he added Fidelity’s field income team is treading carefully in the higher beta segments of the market such as high yield and emerging market debt.

“Diversification remains essential, and we retain a constructive view on duration after the recent rise in government bond yields,” he said. “Taking this into account, we believe long duration assets can play an important role in investors’ portfolios, both as a source of income and as a diversifier to cushion returns against the volatility that we expect in the months ahead.

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