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

The time for bonds has come

Is this the start of a generational bear market in bonds?

Investors need to look beyond bonds for safety

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Shares

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Property

Baby Boomer housing needs

Baby boomers will account for a third of population growth between 2024 and 2029, making this generation the biggest age-related growth sector over this period. They will shape the housing market with their unique preferences.

SMSF strategies

Meg on SMSFs: When the first member of a couple dies

The surviving spouse has a lot to think about when a member of an SMSF dies. While it pays to understand the options quickly, often they’re best served by moving a little more slowly before making final decisions.

Shares

Small caps are compelling but not for the reasons you might think...

Your author prematurely advocated investing in small caps almost 12 months ago. Since then, the investment landscape has changed, and there are even more reasons to believe small caps are likely to outperform going forward.

Taxation

The mixed fortunes of tax reform in Australia, part 2

Since Federation, reforms to our tax system have proven difficult. Yet they're too important to leave in the too-hard basket, and here's a look at the key ingredients that make a tax reform exercise work, or not.

Investment strategies

8 ways that AI will impact how we invest

AI is affecting ever expanding fields of human activity, and the way we invest is no exception. Here's how investors, advisors and investment managers can better prepare to manage the opportunities and risks that come with AI.

Sponsors

Alliances

© 2024 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.