Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 336

Have bonds reached the end of the line?

Bond markets typically perform well during periods of economic uncertainty. All else being equal, decelerating economic growth dampens inflationary pressures, increases the probability of interest rates heading lower.

That has certainly been the case over the last year or so. Economic conditions have softened both within Australia and offshore, and policymakers are debating whether further cuts are warranted.

The deteriorating economic background has been reflected in the local fixed income market. Yields on 10-year Commonwealth Government Securities have more than halved over the past 12 months, from over 2.70% in November 2018 to around 1.20% today. Remember, there’s an inverse correlation between bond yields and prices; the sharp move lower in yields has resulted in favourable returns from fixed income portfolios.

So far so good, but what now?

That’s great for investors who’ve had exposure to bonds recently, but what does it mean for the outlook going forward? Investors are increasingly questioning whether it might be time to lock in gains and remove allocations to fixed income investments. Official interest rates are negative in Europe and Japan and are being lowered elsewhere, most notably in the US. Moreover, increasingly accommodative policy settings by global central banks have driven yields below zero on more than a quarter of government bonds on issue worldwide. How much lower can they go?

It is understandable that investors are questioning whether bonds still have a role to play in portfolios.

In our view, they certainly do. In the interests of full disclosure, First Sentier Investors currently manages more than $15 billion of Australian fixed income securities, so our view probably won’t surprise too many people. But, even after putting unintended biases to one side, there remains a clear case to support ongoing allocations to defensive, income-oriented investments like bonds.

The asset class has an important role to play in most well-balanced, diversified portfolios, even though the future return profile is less appealing than it has been in the past.

The historical reasons for holding bonds include:

1. The low-risk profile 

Even though the overall indebtedness of most countries is increasing worldwide, the risk of default on debt issued by sovereigns in their own currency remains extremely low. Currently, Australian government debt is rated AAA by Moody’s, the maximum possible rating and one that’s only awarded to a handful of issuers worldwide. With the ability to print currency if required to meet debt repayment obligations, the likelihood of non-payment is very low.

2. A reliable source of income

Again, almost all bond issuers – including both governments and companies – are well placed to service their debt-servicing obligations and make regular coupon payments to investors.

While some global bonds are now showing negative yields to maturity, Australian government bonds still offer positive and secure income for investors. Most securities make coupon payments semi-annually. Yields and potential income are higher in corporate debt markets but with an inherently higher risk profile. With interest rates so low, most companies are currently able to comfortably meet their debt repayment obligations and profitability is holding up quite well among high quality firms. Accordingly, while the risk profile of corporate debt is always evolving, credit markets continue to offer opportunities for income-based returns with a relatively low risk of capital loss.

3. A hedge against falls in equities

Allocations to fixed income securities have historically helped preserve capital during equity down markets, effectively providing a cushion against falling share prices.

Even with yields below zero in some regions, the historical negative correlation between equities and bonds during periods of equity market stress is expected to persist worldwide. During times of elevated uncertainty, a ‘flight to quality’ into defensive assets with perceived capital security and plentiful liquidity would be anticipated, helping to maintain the historical relationship between equities and bonds.

Scope for capital appreciation from Australian bonds

If cash rates are lowered further in 2020, government bond yields could conceivably come under further downward pressure. This would push prices higher, augmenting income from coupon payments and lifting total returns. With yields at ~1.20% instead of ~2.70%, the expected return profile of Australian bonds is clearly lower than it was a year ago.

But, importantly, all of the above characteristics are likely to hold over the medium term, underlining the ongoing appeal of bonds as part of a broader asset allocation mix.

 

Stephen Cooper is Head of Australian Fixed Income at First Sentier Investors, a sponsor of Firstlinks. This article is for general information only and does not consider the circumstances of any individual.

For more articles and papers from First Sentier Investors, please click here.

 


 

Leave a Comment:

RELATED ARTICLES

Corporate bond opportunities in today’s market

Duration: Friend or foe in a defensive allocation?

A closer look at defensive assets for turbulent times

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.