A recovery of the global economy could take longer than investors expect, and advisors would be prudent to protect their clients’ portfolios from deflationary risks in the near term, according to Stephen Lingard, co-lead manager of Franklin Templeton’s Quotential Program.

Central banks are not likely to raise interest rates aggressively in the next three to six months, said Lingard, speaking at Franklin Templeton Investments Corp.’s annual Investment Outlook and Opportunities Forum in Toronto on Thursday.

“I think people underestimate how difficult this economic situation is,” he said. “We’re a bit concerned that we don’t get the recovery that we’re all expecting near term.”

Added Lingard: “Rates could essentially stay lower for longer.”

In some markets, he said there is evidence that deflation represents a more prominent concern than inflation. Inflationary pressures are sure to return eventually, but it could take years to get to that point, Lingard said.

As a result, he encouraged advisors to maintain government bond holdings in their clients’ portfolios in the next few months.

“Don’t completely shun the government bond market,” he said. “We do think that they can continue to work short-term.”

When indicators show that inflation is returning and interest rate hikes are more imminent, Lingard said advisors should then shift clients away from long-term government bonds. But not all fixed income products will suffer.

“Rising rate environments can actually be very good for certain parts of the bond market,” he said. “There are still good opportunities.”

In particular, Lingard expects high yield debt, floating rate notes, and certain corporate bonds to do well as interest rates rise, since these types of securities tend to benefit from healthier economic conditions.

And these holdings won’t necessarily be of lesser quality. While corporate bonds have traditionally been considered lower quality debt than government bonds, the sovereign debt crisis in Greece and other parts of Europe has shown that this is not always the case, Lingard said. He considers the quality of certain corporate bonds to be relatively higher than government bonds in the current environment.

“Corporations are cash-rich,” he said. “There are still opportunities, I think, to add yield to the portfolio and ultimately have a very, very sound investment.”

In the meantime, Lingard warned that economic uncertainty will likely continue to drive volatility in bond markets.

“Higher volatility is going to be the order of the day as markets move between betting on inflation, and betting on deflationary outcomes.”

In this type of volatile environment, Lingard recommends ensuring that clients’ fixed income assets are properly diversified.

IE