Institutional investors have increasingly turned to alternative assets as a means of improving portfolio resilience, managing risk, and capitalising on opportunities unavailable in public markets. Australian Retirement Trust (ART) has been a key participant in this shift, developing a strategic approach to investing in unlisted assets that balances risk and opportunity.
The planned transition of $44 billion worth of additional Tier 1 (AT1) bank hybrids to Tier 2 capital by 2032 will see the last bank hybrid disappear by March 2032, bringing to an end an era that income-oriented Australian Securities Exchange (ASX) investors will remember mostly fondly. In this guest article, Simon Dawkins, Partner and Head of Capital Markets at Escala Partners, lifts the lid on a better alternative for sophisticated investors.
The fixed income outlook: Sunny with a chance of showers
A golden age for fixed income, but with caution
“We’ve entered a golden age for fixed income,” Karunakaran stated. “After years of suppressed yields and unattractive spreads, the asset class is offering real returns again. The difference now is that we need to be extremely selective. The easy money era is over.” After a long period of ultra-low interest rates, he said, bonds are once more “making a compelling case” for portfolio inclusion.
“For the first time in a decade, we’re seeing investors genuinely excited about fixed income,” Karunakaran remarked. “We’re looking at 5 per cent–6 per cent yields in some high-quality bonds, and that’s before we even touch credit.” However, he was quick to caution against complacency: “The risk is assuming this is a stable environment when in reality, central banks are still fighting inflation, and the endgame is unclear.”
Inflation remains a key risk
The persistence of inflation remains a looming factor. While recent data suggests that price pressures are easing, structural forces – such as deglobalisation and fiscal expansion – suggest inflation could remain higher than pre-pandemic levels. “The fixed-income playbook of the last twenty years no longer applies,” Karunakaran warned. “Duration risk is back, and bond investors need to think differently about how they position portfolios.” With government bond yields recovering, the allure of credit has shifted. “Investment-grade corporate bonds are now offering spreads that make sense for the first time in years,” Karunakaran observed. “But high-yield markets are trickier – there’s opportunity, but you have to be mindful of credit quality and liquidity.”
The role of private credit
Private credit also emerged as a major talking point. “Private credit has been one of the best-performing asset classes in recent years,” he said. “The dislocation in traditional lending channels has created an opening for institutional investors willing to take on illiquidity risk. But let’s not kid ourselves – liquidity can be a real issue when market stress hits.”
Interest rate uncertainty and market volatility
One of the debated topics of the evening was the trajectory of interest rates. “Markets are pricing-in rate cuts later this year, but the question is: how many and how soon?” Karunakaran queried. “A lot of investors are making the mistake of assuming a smooth glide-path down. But if inflation surprises on the upside again, central banks will have little choice but to keep rates higher for longer.” Several attendees echoed concerns about the volatility that such uncertainty could bring. “We’re in an environment where we have to hedge interest rate risk more actively than before,” one asset allocator noted. “Duration is both a friend and a foe – it’s a balancing act.”
The liquidity challenge
Liquidity – or the lack thereof – was another recurring theme. “The shift from quantitative easing to quantitative tightening has profound implications for market liquidity,” Karunakaran highlighted. “Secondary market liquidity in fixed-income is not what it used to be. If we get another credit event, bid-ask spreads could widen dramatically.” This was a key consideration for advisers who need to balance return-seeking with capital preservation. “There’s a real case for having more cash-like instruments or very short-duration exposure,” he suggested. “They provide optionality in an uncertain market.”
Holding cash, however, may prove costly as central banks move into a rate-cutting cycle. Investors who lock in elevated yields now could secure longer-term income stability, a point underscored by recent historical trends showing attractive returns when investing at the peak of rate cycles.
A new approach to fixed income allocation
While equities remain the dominant driver of returns for many investors, fixed-income’s resurgence has forced a rethink in asset allocation. “This is no longer just a defensive asset class,” Karunakaran noted. “There are return opportunities here that are comparable to equities but with lower volatility.”
A diversified, flexible approach to bond investing is increasingly seen as a way to navigate this evolving landscape. By combining exposure to investment-grade, high-yield, and emerging market debt, investors can structure portfolios to capture the benefits of various income sources while mitigating risks.
A renewed role in portfolios
One case study of a client conversation summarised a re-emergence of the relevance of bonds after a bruising year in equity markets. “They’re seeing bonds do what they’re supposed to do, once again: provide income and diversification. That hasn’t been the case for a long time.” The consensus at the dinner was clear: the fixed-income landscape is rich with opportunities but fraught with complexity. “This is not a set-and-forget environment,” Karunakaran concluded. “Active management matters more than ever. Whether it’s credit selection, duration positioning, or managing liquidity risk, investors who take a hands-on approach will be best-positioned to navigate what’s ahead.”
Final thoughts
As the evening drew to a close, there was agreement that while fixed-income has returned to the spotlight, it remains an asset class that demands careful stewardship. The forecast is, as Karunakaran put it, “Sunny with a chance of showers – stay prepared.”
