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.


 

Leave a Comment:

RELATED ARTICLES

Your bond questions answered

banner

Most viewed in recent weeks

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Welcome to Firstlinks Edition 606 with weekend update

The boss of Australia’s fourth largest super fund by assets, UniSuper’s John Pearce, says Trump has declared an economic war and he’ll be reducing his US stock exposure over time. Should you follow suit?

  • 10 April 2025

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

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.

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

Investment strategies

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.

Investment strategies

Does dividend investing make sense?

Dividend investing offers steady income and behavioral benefits, but its effectiveness depends on goals, market conditions, and fundamentals - especially in retirement, where it may limit full use of savings.

Economics

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.

Strategy

Ageing in spurts

Fascinating initial studies suggest that while we age continuously in years, our bodies age, not at a uniform rate, but in spurts at around ages 44 and 60.

Interviews

Platinum's new international funds boss shifts gears

Portfolio Manager Ted Alexander outlines the changes that he's made to Platinum's International Fund portfolio since taking charge in March, while staying true to its contrarian, value-focused roots.

Investment strategies

Four ways to capitalise on a forgotten investing megatrend

The Trump administration has not killed the multi-decade investment opportunity in decarbonisation. These four industries in particular face a step-change in demand and could reward long-term investors.

Strategy

How the election polls got it so wrong

The recent federal election outcome has puzzled many, with Labor's significant win despite a modest primary vote share. Preference flows played a crucial role, highlighting the complexity of forecasting electoral results.

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.