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Inflation-driven monetary policies create a challenging outlook for these funds.
The loss of value in fixed income investments during the economic turmoil surprised many investors. The year 2022 proved to be exceptionally difficult, described by the Inverco Observatory’s research director as having the worst profitability decline on record. The decline averaged around 8% for the year. Spaniards held 101,000 million euros in these funds, most with a long-term horizon. Why did losses occur? Is fixed income still an attractive investment when bonds carry risk?
In such extraordinary circumstances, a common misconception is that fixed income investments are risk-free. AEPF vice president Javier Santacruz notes, “People expect steady returns, but the reality is more nuanced.”
The decline in bond prices is largely linked to central banks continuing to raise interest rates and tighten monetary policy to curb inflation. On March 16, the European Central Bank (ECB) completed its sixth consecutive rate increase, bringing rates to 3.5% after a decade of negative rates. This directly affects the yields available on bonds purchased before the rise.
An economist from CaixaBank Research explains that the price of a bond moves inversely with its interest rate. When rates rise, existing bonds lose value because newer issues offer higher yields. Some market observers note that bonds with similar characteristics can be issued at better rates than those already in circulation, which drives down the prices of existing securities. Despite these effects on bond funds, investment activity did not dry up. Approximately 6,000 million euros were invested during the period.
In summary, fixed income is not truly fixed, though Treasury bills stand out as an exception. The higher the yield, the greater the potential profit, and these instruments appeal to investors seeking returns of more than a few percent.
taking losses into account
Experts say the best-performing funds during these periods have included Spanish and Italian government bonds and corporate debt with high credit quality. “Dollar-linked funds also show resilience,” notes Victor Alvargonzalez, a specialist at the independent consulting firm Nextep Finance.
Yet the rate hikes do not deter new buyers. “Those who take advantage of the rising rates to buy fixed-income funds are likely to see more positive returns as losses gradually reverse,” says Manrique. Indeed, in the first two months of the year there was a small recovery in profitability, around 0.3%.
an opportunity to rest and regroup
Experts point out that a monetary correction is expected at some point after years of negative interest rates, but the timing and magnitude are hard to predict. For investors who do not anticipate the shift, financial advisors warn against abandoning positions prematurely, as doing so may foreclose the chance for a rebound. “Once losses accumulate, exiting late is rarely a good idea because the rebound window can close early,” Santacruz adds.
The head of the National Securities Market Commission (CNMV) recently cautioned that fixed-income prices are not fixed, and even long-term products carry risk, especially when rate expectations shift. Investors should consider the trajectory of interest rate curves and the potential for future volatility when evaluating fixed-income allocations.