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Vivek Prabhu: How floating rate credit can help investors in a high-inflation environment

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Investors concerned about persistent inflation should consider lifting their exposure to floating rate credit, says Perpetual’s Vivek Prabhu.

NET-ZERO transition costs and a post-pandemic trend away from globalisation look like underpinning inflation for years to come – posing a challenge to the value of interest rate-sensitive fixed income investments.

But by shifting allocation from fixed to floating rate credit, investors could achieve reliable income while potentially protecting their portfolio from capital losses, argues Perpetual’s Vivek Prabhu.

“With inflation elevated, central banks respond with cash rate increases,” says Prabhu, Perpetual's head of fixed income.

“Floating rate funds can benefit from extra income generated, without the inverse relationship between capital and yields that you have with fixed rate bonds.

“That can provide a good hedge against inflation as well as generating income.”

The role of floating rate notes

Floating rate notes (FRNs) are bonds with variable interest rates that change with movements in broader interest rates, usually in line with an official rate like the 90-day Bank Bill Swap Rate.

This means that in a rising interest rate environment, the income generated by floating rate notes should increase along with the interest rate, delivering investors extra income.

Importantly, this also means FRNs should avoid the inverse relationship between price and yield suffered by fixed-rate bonds, which decline in value when interest rates rise because their fixed interest rate becomes less attractive.

Typical assets in Prabhu’s Perpetual Diversified Income Fund include corporate, bank and securitised debt (such as home mortgages, car loans, office equipment financing, and medical equipment financing).

Rate rises still on the cards

Continued rate rises are still likely as central banks fight inflation,” Prabhu believes.

“A lot of the things that were suppressing inflation over the last 15 years have done a 180-degree turn.

“Globalisation and China becoming the world's manufacturer has applied deflationary pressure historically.

“But moving forward, the developed world has recognised supply chain vulnerabilities and is onshoring manufacturing again — which is inflationary.

“Wage inflation is back in the tight employment market and people are demanding increases in wages.

“Decarbonisation is another — the flow-on impact to consumers from new taxes and investment to offset carbon emissions.

“These things are structurally embedding inflation at a higher level than we've seen over the last 10 or 15 years.”

Credit risk premiums

Prabhu says price movements in floating rate credit typically relate to credit risk premiums as measured by credit spreads.

Credit spreads represent perceptions of the risk associated with a particular investment.

“If credit risk premiums are rising, that makes the floating rate bond fall in value. Whereas if credit risk premiums are stable or falling, you’re either collecting the yield or making a capital gain on the contraction in credit risk premiums.”

Prabhu says the default history on Australian bonds – the times when borrowers failed to pay back their loans on time – is lower than the equivalent rating for US bonds.

That’s partly a result of the fact Australia is a small, protected economy with a high number of oligopolies, which makes for good credit risk.

Prabhu argues that floating rate credit provides the opportunity to earn a cash-plus return for taking very high quality, predominantly investment grade credit risk.

“We believe credit is the most repeatable and reliable source of alpha when investing in fixed income.”


About Perpetual’s Credit and Fixed Income team

Perpetual offers a range of cash, credit and fixed-income solutions and are specialists in investing in quality debt.

We take a highly active approach to buying and selling credit and fixed income securities and invest extensively across industries, maturities and the capital structure.

Find out more about Perpetual’s Credit and Fixed Income capabilities

Want to find out more? Contact a Perpetual account manager

Vivek Prabhu
Head of Fixed Income
BBus, FCA, Grad Dip App Fin & Inv, MBA, GAICD
Vivek Prabhu

Vivek Prabhu

Head of Fixed Income BBus, FCA, Grad Dip App Fin & Inv, MBA, GAICD

Years of experience: 31
Years at Perpetual: 19

Vivek is Head of Fixed Income and joined Perpetual in 2004. He has over 30 years of experience spanning accounting, finance, investments, governance and risk management. He has managed multi-billion dollar fixed income, credit and currency portfolios and his role involves credit analysis, trade execution and portfolio construction.

Previously, he spent nearly 8 years at Macquarie Bank in roles including Assistant Portfolio Manager (Credit, Global Fixed Interest and FX), Credit Analyst, Compliance Manager (Funds Management Group) and Operational Risk Analyst (Internal Audit). Prior to this, Vivek spent almost 4 years at Coopers & Lybrand (PwC) as an accountant / auditor.

He's aimed to give back to the communities, organisations and people with whom he's connected. Vivek joined the Board of The Deaf Society of NSW in 2011 and currently serves as Director and Treasurer. He joined Perpetual's Diversity Council in 2012, chaired by Perpetual's CEO. Since 2010, Vivek has regularly mentored university students, colleagues & finance industry professionals, leading the Fixed Income stream for Perpetual's Investment Analyst Program.

He was awarded the 2011 Financial Services Institute of Australasia (FINSIA) Hugh DT Williamson Performance Scholarship, an award recognising professional accomplishment, social responsibility and leadership. In 2011, he was also awarded a not for profit directors scholarship from the Australian Scholarship Foundation.

This article has been prepared by Perpetual Investment Management Limited (PIML) ABN 18 000 866 535, AFSL 234426, as the issuer of the Perpetual Diversified Income Fund ARSN 601 199 035 (Fund).

It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The information is believed to be accurate at the time of compilation and is provided in good faith. It may contain information contributed by third parties. PIML does not warrant the accuracy or completeness of any information contributed by a third party.

Forward-looking statements and forecasts based on information available at the time of writing and may change without notice. No assurance is given that the forecast will prove to be accurate, as future events may impact actual results and these could differ materially from those anticipated. Any views expressed in this article are opinions of the author at the time of writing and do not constitute a recommendation to act.

The product disclosure statement (PDS) for the Perpetual Diversified Income Fund, issued by PIML, should be considered before deciding whether to acquire or hold units in the Fund. The PDS and Target Market Determination can be obtained by calling 1800 022 033 or visiting our website www.perpetual.com.au.

No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor's capital. No allowance has been made for taxation and returns may differ due to different tax treatments. Past performance is not indicative of future performance.