Investors worried about inflation should consider buying short-dated bonds, rather than moving out of bonds altogether, according to investment management firm PIMCO.
"For those investors looking to protect themselves from inflation, a portfolio of short-dated bonds, including floating rate notes, is an excellent place to start," PIMCO vice president Matthew McLenaghan said.
PIMCO research showed that an even mixture of bank bills and Australian bonds produced an investment return of almost 3 per cent above the consumer price index in the past 10 years and 4.7 per cent above inflation over 20 years.
"Inflation-linked bonds are one obvious investment for investors worried about inflation, but they tend to be very long dated," McLenaghan said.
"This could be a concern for those worried about rising rates, as their longer duration might introduce some interest rate volatility into the portfolio."
"Shorter-dated bonds can help to hedge inflation while at the same time limiting volatility and providing attractive real rates of return. The flat yield curve in Australia means you aren't giving up much in yield by moving to shorter-dated bonds either."
The flat yield curve in the Australian bond market means that investors do not get rewarded for investing in longer dated bonds and taking the duration risk to the same degree as investors in overseas markets.
UBS Global Asset Management head of fixed income Asia Pacific Anne Anderson said this was flaw in the market.
"I would quite like to see a lot more issuance [of long-dated bonds], because it would lengthen out the duration of our market, and making it more similar to other global develop markets, that is a flaw in our investment universe," she said during a Russell Investment presentation earlier this week.
"The fact that investors have gone to cash and holding high levels of cash is telling you something about the growth centricity and what happened to investor returns over the past couple of years."
Yet, for some investors it might make sense to increase their fixed interest allocation to the Australian market, where the outlook for inflation and scope for rising rates is more subdued.
"For investors who have domestic liabilities that they are trying to match, it might make sense to move part of their fixed interest exposure back to Australia," he said.
"Keep in mind though that you're likely to give up some yield straightaway."
He said that despite the relatively flat yield curve, there were still pockets of the Australian fixed income market that offered good value.
"In Australia, we still favour residential mortgage-backed securities, but we are very particular about the issues we buy. We also still favour Australian government guaranteed bank debt," he said.
