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A bond investor’s worst enemy

Reading Time: 2 minutes

There has been talk in the press over the last few months about whether tariffs will push the US economy towards higher inflation. We will address that question in a later post, but for now we address something more fundamental to bond investors – why is inflation a big deal?

One of the reasons that some investors are attracted to fixed income is the regular income that the asset class provides. A fixed rate bond provides the cash flow profile depicted in the diagram below – a series of fixed interest payments followed by the return of principal:

Inflation is defined as increases in the prices of goods and services. For an investor relying on a stream of fixed income payments similar to that depicted above, it is clear why inflation is detrimental: all else being equal, higher inflation reduces the purchasing power of fixed payments. Payments remain fixed while the price of goods and services increases.

At Daintree Capital, we provide income streams that seek to mitigate inflation risk to the extent that is possible. The Daintree Core Income Fund invests in floating rate debt, which provides a higher income as interest rates rise. This is useful because an inflationary environment is one where central banks would most likely seek to raise interest rates. In addition, at times we may find that inflation-linked securities represent good value in our portfolios. These are securities whose income streams are designed to increase in line with inflation, or protect against unanticipated increases in inflation.

There is no portfolio that provides perfect protection to investors seeking to mitigate inflation risks. That said, an investment approach that seeks to add some protection against increased inflation over time when such strategies are cost effective will be well-placed to provide a sustainable, long-term income stream to investors.

 

The author, Justin Tyler, is a Director & Portfolio Manager at Daintree Capital. Click on the links find out more about Daintree Capital’s Core Income fund and High Income fund.

 

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