Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 552

Credit trumps residential property for headache-free income

Investment grade (IG) portfolios can offer returns of 7-8% and, importantly, the likelihood of any significant default cycle appears small.

Australian bond and fixed-income managed funds saw strong net fund inflows over 2023 and that trend has continued into the early part of 2024. That does not happen very often but when it does, it can produce equity like returns from fixed interest assets and with a much lower risk of capital loss. I believe investors are starting to understand that, and that's the real attraction of investment grade (IG) rated portfolios.

One interesting trend we have increasingly observed is that IG deals coming to market are offering better returns than so called ‘safe haven’ asset classes, in particular the Australian residential property market (refer Chart 1).

The challenge is delivering compelling risk-adjusted returns. Here we take the view that global governments will focus on maintaining stability in their economies, resulting in higher-for-longer inflation and interest rates. Under this scenario, the cost of debt would remain higher for an extended period - an excellent backdrop for credit investors. The return prospects look increasingly attractive: investors can lock in higher yields than cash and with limited interest rate or spread risk. While recent IG credit returns compare favourably to the average total returns available from equities, comparing with residential investment property paints an especially stark picture.

Credit opportunities

In terms of our investments across the Australian multi-asset credit universe, key positions have been in bank-issued Tier 2 hybrid debt (T2s) and residential mortgage-backed securities (RMBS). The market is increasingly comfortable that we’re not going to have a house price crash and is factoring in an environment where central banks stop hiking and eventually start easing rates (from as early as August in Australia). We’re seeing credit spreads performing very strongly because of the attractiveness of the outright yields and the comfort investors have with those IG corporates and issuers. It’s a thematic that is likely to continue.

Compared specifically to residential property, we believe IG credit offers an appealing and hassle-free alternative for stable and attractive income, without the headaches associated with owning investment property. Yields of 6-7% across T2s and RMBS compare to residential property rental yields of just 2% (refer Chart 2).

While we’re not suggesting holders of Australian investment property should all rush for the exits, it is worth contemplating the go-forward return profile for what is one of Australia’s long favoured asset classes.

With such a significant gap in return profiles, investment property owners would need to see significant capital growth to make up the difference. And with a stable outlook for house prices, it’s difficult to see that happening. Meanwhile, taxes are rising for Australian property investors and there is clearly some uncertainty around the future of negative gearing.

The outlook for investment grade credit

Looking forward, we think bank issued hybrid capital, particularly T2s, are still attractively priced and that they will continue to provide a source of strong outperformance. RMBS is still a robust sector, as we continue to see households prioritising their mortgage repayments over discretionary spending. With house prices having essentially returned to their previous peaks, and borrowing capacity determined by income capacity, it is difficult to imagine a scenario where the next leg up for house prices comes from. Finally, combined with uncertainty around the government’s future tinkering to both negative gearing and capital gains tax, potential for still higher land taxes in some States, and the increasing rights of tenants, it’s understandable why many property investors are more likely to be thinking of selling up rather than buying.

It’s clear that investors see IG credit as a defensive play and as a security that should perform well in a recession. History has shown that rate hiking cycles by central banks often lead to a recession and so it must remain a consideration. However, even in a recessionary environment with mild negative growth, IG credit offers a compelling alternative to cash. There are parts of the credit market that are more vulnerable in the event of recession, but IG credit ratings underscore companies that can more easily service debt and, therefore, are better able to weather the negative impact of a recession on profitability. 

 

Phil Strano is a Senior Portfolio Manager at Yarra Capital Management. This article contains general financial information only. It has been prepared without taking into account your personal objectives, financial situation or particular needs.

 


 

Leave a Comment:

RELATED ARTICLES

Is the best value for Australian credit not in Australia?

Can Australian credit continue to perform?

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

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. 

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.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

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?

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Latest Updates

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.

Shares

Boom, bubble or alarm?

After a stellar 2025 to date for equities, warning signs - from speculative froth to stretched valuations - suggest the market’s calm may be masking deeper fragilities. Strategic rebalancing feels increasingly timely.

Property

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.

Economy

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. 

Shares

Is the iPhone nearing its Blackberry moment?

Blackberry clung on to the superiority of keyboards at the beginning of the touchscreen era and paid the ultimate price. Could the rise of agentic AI and a new generation of hardware do something similar to Apple?

Fixed interest

Things may finally be turning for the bond market

The bond market is quietly regaining strength. As rate cuts loom and economic growth moderates, high-quality credit and global fixed income present renewed opportunities for investors seeking income and stability. 

Shares

The wisdom of buying absurdly expensive stocks (or not!)

Companies trading at over 10x revenue now account for over 20% of the MSCI World index, levels not seen since the dotcom bubble. Can these shares create lasting value, or are they destined to unravel?

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.