Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Bond investing as rates rise

Last week, Jim McKay argued there is limited appeal of investing in developed country bonds, where real interest rates (nominal interest rates less inflation) currently provide little, or even a negative, return to bond holders.

Warren Bird, formerly Co-Head of Global Fixed Interest and Credit at Colonial First State Global Asset Management, responds:

Of course you could accept the fact that rising yields produce higher returns and just relax. I've been writing and speaking for 20 years about the misplaced fear of rising bond yields. It's a simple message: fixed interest investing is all about the interest you earn. As yields go up, you get to reinvest income or maturing bonds at those higher yields, which ratchets up your interest earnings. Bond price volatility is just that - volatility.

The best example is the return from Australian bonds to investors who entered the market just before the sell off in 1994. They bought a portfolio yielding about 6%. Over the next 3 years they actually earned 8% pa. How, when 1994 was so terrible? Well, although they earned about -5% in 1994, the reinvestment income from putting maturing money back to work at 9, 10 and 11% lifted the returns during 1995 and 1996. Yields were back around 6% after 3 years, so there's no capital gain involved - just higher reinvestment earnings. If the bear market of 1994 hadn't happened, then returns over the 3 years to 1997 would have been lower, at around 6% pa.

There's a very good reason why fund managers advise you to look at investing in bonds over a 3-5 year time frame. Because that's when the short term volatility of bond prices mostly washes out and you earn the income you expect to when you make your investment.

Sure, if you knew that a rise in yields was coming you would be sensible to shorten up your duration, avoid the mark to market loss, and then put your money back into those higher yields. But can we be so sure that yields must rise from now? They've already backed up by well over 1% during 2013 and frankly a ten year government guaranteed income stream of 4.25% pa, that will rise if yields go up, doesn't actually look too bad if you have even the slightest concerns about the health of the world economy.

Therefore, I believe that a perfectly valid strategy in a rising yield environment is simply to reinvest your cash flows and enjoy the higher returns you end up earning.

  •   3 December 2013
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Your bond questions answered

banner

Most viewed in recent weeks

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

The housing market is heading into choppy waters

With rates on hold and housing demand strong, lenders are pushing boundaries. As risky products return, borrowers should be cautious and not let clever marketing cloud their judgment.

Latest Updates

Interviews

AFIC on the speculative ASX boom, opportunities, and LIC discounts

In an interview with Firstlinks, CEO Mark Freeman discusses how speculative ASX stocks have crushed blue chips this year, companies he likes now, and why he’s confident AFIC’s NTA discount will reverse.

Investment strategies

Solving the Australian equities conundrum

The ASX's performance this year has again highlighted a persistent riddle facing investors – how to approach an index reliant on a few sectors and handful of stocks. Here are some ideas on how to build a durable portfolio.

Retirement

Regulators warn super funds to lift retirement focus

Despite three years of the retirement income covenant, regulators warn a widening gap between leading and lagging super funds, with weak member insights and patchy outcomes measurement threatening retirees’ financial futures.

Shares

Australian equities: a tale of two markets

From soaring government deficits to the rise of network giants, equity markets are marked by persistent imbalance and rapid structural change. In this environment, opportunity favours those willing to look beyond the obvious.

Investment strategies

Dotcom on steroids Part II

OpenAI’s business appears commoditized and the model is not sustainable in the long run. If markets catch on, the company could face higher borrowing costs, or worse, and that would have major spillover effects.

Investment strategies

AI’s debt binge draws European telco parallels

‘Hyperscalers’ including Google, Meta and Microsoft are fuelling an unprecedented surge in equity and debt issuance to bankroll massive AI-driven capital expenditure. History shows this isn't without risk.

Investment strategies

Leveraged single stock ETFs don't work as advertised

Leveraged ETFs seek to deliver some multiple of an underlying index or reference asset’s return over a day. Yet, they aren’t even delivering the target return on an average day as they’re meant to do.

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.