Rising interest rates were a major investment theme of 2022. Australia was in a streak of eight rate increases. Today the cash rate is 3.10%, its highest in a decade. Global central banks are also in the process of tightening.

However, as difficult as it has been for borrowers, the higher cash rate is a plus for yield-starved investors and several asset classes now pay good returns, particularly with risk assets,” bonds and cash boss.

Bonds are back

Most of the bond managers with which director of manager selection Aman Ramrakha has been speaking are positive about the environment of increasing interest rates, he says.

“These bond managers think they are now in an environment where they can produce some reasonable returns in this environment with the higher coupons that bonds are providing now,” Ramrakha says.

Coupon is the amount of annual interest paid on a bond. With cash rates at artificially low levels, this has been hard, says Ramrakha. And now that cash rates are rising, bonds should offer more income.

His caveat is that on the "on-market-to-market" basis, bonds have realized paper losses. In other words, bonds were priced to increase according to market conditions.

“There will still be market volatility so the market-to-market pricing of these bonds might not recover. However, these losses will still be only on paper,” Ramrakha adds.

“The good news is that the income attributes of bonds have improved. Bonds should still be a haven for investors to earn better income.”

Speaking of first principles, he’d invest in Australian bonds ahead of global bonds, mainly because “the economic outlook here is better than it is in global markets”.

Good bond managers in coverage were the Janus Henderson Tactical Income Fund and the Yarra Australian Bond Fund.

It’s a fine hedge against equity despite the 2022 experience where bonds and equities had been correlated. Forecasters predict there will be at least a mild recession, probably focused in the United States and Europe, and here bonds are in a better position, because they already carry a perception that they are a safe asset, and could in theory be the beneficiaries of a flight to safety.

A fistful of cash

In years of attenuated interest rates, such as in 2020 and 2021, term deposits offered meagre returns.

Savers have been "left holding the bag" at the big banks. The RBA's rate hikes have been pushed through in full on the way up, but not for savers although if investors are willing to look off banks' shop shelves there's some good news.

Comparison site RateCity says the top ongoing adult savings rate available to all adults hit 4.60% in December, offered by Virgin Money. And for term deposits, AMP for instance has rates on 12-month fixed term deposits above 4 per cent.

“We’re now starting to see competition in the market from the annuity providers and other institutions giving attractive rates on term deposits. Those should be appealing for conservative investors,” Ramrakha says.

Equities with appeal

Higher interest rates also raise the outlooks for many businesses. It’s a topic addressed in a recent adviser webinar featuring director of equity research Mathew Hodge.

Sectors including AREITs and financials services are rate rise sensitive, but there are a raft of businesses that Hodge believes can benefit from higher rates, in particular any company that is able to generate free flowing cash that will earn interest. “There will be companies that will benefit from the very fact that interest rates are rising,” Hodge says.

Annuity provider Challenger (GGF) and share registry business Computershare (CPU) are instances, Hodge said.

The high interest rate environment increases the appeal of annuity products and should enable Challenger to achieve a better return on an annuity holder’s funds, Hodge says. In its September trading update, the company even said annuity sales had increased by 50%.

And Computershare also upgraded guidance on its margin at the trading update, again with a tailwind from interest rates. Computershare had material interest rate exposures as a result of bank balances which attracted interest.

“Not the cheapest businesses, but we like the addition to the quality,” Hodge says.