Opportunity for fixed income investors?
Concerns of a more hawkish Fed is causing volatility in the global stock market, including the Philippines.
On the positive side, this is creating an opportunity for investors with a lot of excess cash to finally deploy their money and earn higher yields as interest rates on fixed income products have gone up.
Admittedly, interest rates on bank deposits remain low. This is because of ample liquidity as the economy is still recovering from the pandemic and demand for loans remains weak.
Nevertheless, the yields on 5-year and 10-year government bonds are already at 4.62 percent and 5.39 percent respectively. These rates are above both their respective five-year historical averages and end 2019 levels.
An instrument that retail investors can now buy to capitalize on higher interest rates is retail treasury bonds or RTBs. Up to Feb. 28, investors with as little as P5,000 can go to several banks to buy these 5-year bonds with a coupon of 4.875 percent.
Aside from being more affordable than other bonds, the reason why I find this RTB attractive is because its coupon is higher than the 4.38 percent average yield for 5-year bonds during the past five years. It is also higher than the 5-year bond rate as of end 2019 of 4.06 percent.
Although domestic interest rates could go up some more as the US Fed starts raising rates in March, I believe that the impact will be more on shorter-term interest rates (less than five years) since interest rates on longer-term bonds have already gone up recently, pricing in the rate hikes. As mentioned earlier, the 5-year and 10-year government bond rates are already at levels that are above where they were as of end-2019, prior to the pandemic.
Personally, I don’t think domestic long-term rates have much room to go up, especially not on a sustainable basis. Although January inflation in the United States jumped to a 40- year high, there are signs that inflation is already peaking as consumer demand is weakening and as supply bottlenecks are slowly being resolved. Moreover, while the Fed is expected to be more aggressive in raising rates this year, it is still not expected to bring rates back to prepandemic levels.
Locally, inflation is under control and well within the BSP’s target range of 3 percent to 4 percent. Also, although the government now has a larger budget deficit and a higher debt level because of the pandemic, the uptrend should reverse soon as economic growth is picking up. This is the main reason why Fitch recently affirmed its “BBB” rating on the Philippines despite the country’s higher deficit and debt level.
For investors with higher risk tolerance, you can also buy real estate investment trusts or REITs as prices of REITs have also gone down because of higher interest rates.
The average 2022 dividend yield of Philippine REITs is now 5.5 percent. Although this is only at par with the 10-year government bond rate, cash dividends of REITs are taxed at only 10 percent. On the other hand, coupons on bonds are taxed at 20 percent. As such, the after-tax yield of some REITs is already higher than that of the benchmark government bond.
Moreover, while coupons on bonds are fixed over the life of the bond, the dividends of REITs go up over time due to rental escalation and yield accretive acquisitions. This explains why REITs whose sponsors have more mature quality rental assets that they can inject into their REIT companies trade at lower yields.
Buying bonds or REITs is a good way to take advantage of higher rates brought about by concerns of a more hawkish Fed. The decision on which instrument to buy will depend on your risk appetite, with bonds being more suitable for conservative investors who want fixed returns and REITs more suitable for investors who are willing to take on more risk to generate higher returns. INQ
