Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 84

Your bond questions answered

Warren Bird’s previous article, An idiot’s guide to bond funds, was written in response to a message from James, a Cuffelinks reader, who asked for an explanation of bonds in layman’s terms. This article wraps up the series, addressing the remainder of James’ questions.

Should one invest in bonds for income or capital gain?

Bond returns are income returns over time; you can speculate about short term market movements if you want, and try to time your entry to achieve capital gains, but the nature of bonds and bond funds is income returns.

Are there some bond funds that should be included in the growth section of a portfolio as opposed to the defensive?

Funds that invest in lower rated corporate bonds and high yield are more closely correlated with equity market returns and thus don't perform the same defensive role as a portfolio of Australian government bonds. But they still aren't 'growth funds' so they don't belong there. Some funds have a category for 'middle risk' or 'alternative defensive' assets that they put credit and high yield into.

Is a 70/30 split crazy when interest rates are at all time lows?

Not in my view. The concern seems to be that bonds will perform poorly when rates go up. However, just because rates are low doesn't mean they are going to go up significantly; even if they do, it means your expected future returns will ratchet up as rates go up. And equities are pretty fully valued so it's quite possible that they will fall sharply when bond rates go up.

What are the merits of passive vs active investing in bonds (it is my understanding that most bond funds have underperformed passive funds over the past ten years, much like active equities funds)?

It's not true that most bond funds have underperformed - in fact, most have outperformed passive funds. The issue for many super funds, etc is that the amount of outperformance from bonds is much less than in other asset classes, so they would rather allocate fees to seeking higher excess returns than bond managers can deliver. I think you should focus on after-fee returns and if you can get value add from any asset class you should be willing to pay for it.

Please explain these new-fangled ‘unconstrained bond funds’.

The gist is that they are funds that try to get value out of trading short term views of bond markets and sometimes equity markets, too. The specific strategies are unique to each fund and the skill set of the managers on their team.

Are they just a fad?

I gave a short response to this very question in the comments section of this piece, What’s that UBS bond benchmark in the annual statements?. I personally invest in them so I don't think they are a fad. They have a place in the risk-return spectrum.

Are they a genuine solution to the duration risk argument?

That's not the reason I would invest in them. Duration risk is worth taking - with positively sloped yield curves you get paid to take duration risk.

Have they been created in response to bond fund managers wondering where the next dollar will come from after a 30 year bull market?

No doubt that was the motivation for some of them, but since most of them were developed several years ago before talk of 'the end of the 30 year bull market' took hold, it's probably not true for the sector as a whole. A less pejorative view is that end-investor demand for more income-focussed products that weren't constrained to just bonds led to products being developed to meet that demand. I personally think that funds with duration have a place in many portfolios and I have some in my own SMSF.

 

Warren Bird was Co-Head of Global Fixed Interest and Credit at Colonial First State Global Asset Management. His roles now include consulting, serving as an External Member of the GESB Board Investment Committee and writing on fixed interest. His comments are general in nature and readers should seek their own professional advice before making any financial decisions.

 


 

Leave a Comment:

RELATED ARTICLES

Busting the bond myth

Does gold still deserve a place in a diversified portfolio?

Corporate bond opportunities in today’s market

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Economy

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Investing

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Property

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Shares

ASX reporting season: Room for optimism

Despite mixed ASX results, the market has shown surprising resilience. With rate cuts ahead and economic conditions improving, investors should look beyond short-term noise and position for a potential cyclical upswing.

Property

A Bunnings play without the hefty price tag

BWT Trust has moved to bring management in house. Meanwhile, many of the properties it leases to Bunnings have been repriced to materially higher rents. This has removed two of the key 'snags' holding back the stock.

Investment strategies

Replacing bank hybrids with something similar

With APRA phasing out bank hybrids from 2027, investors must reassess these complex instruments. A synthetic hybrid strategy may offer similar returns but with greater control and clearer understanding of risks.

Shares

Nvidia's CEO is selling. Here's why Aussie investors should care

The magnitude of founder Jensen Huang’s selldown may seem small, but the signal is hard to ignore. When the person with the clearest insight into the company’s future starts cashing out, it’s worth asking why.

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.