Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 298

Briefly, on the role of government bonds

The recent article by Paul Chin advocated a role for government bonds in a diversified portfolio at all times.

I’m more in the ‘against’ camp than the ‘for’ camp. I disagree that government bonds should always play a role in a diversified portfolio. It’s too long a bow to draw for one of the lowest-yielding asset classes. In another article on government bonds, Jonathan Rochford makes a good point that the cost of gaining this diversification is too great if it has to be obtained by owning an asset class that delivers a low return over time.

The role of government bonds in some portfolios

I advocate holding government bonds if there’s a particular requirement for the security and liquidity and a specific investment need. For example:

  • Insurance companies need funds maturing at various dates in the future, with absolute certainty about the value of the asset that matures
  • Banks need high quality liquid assets to meet unexpected levels of withdrawals and as part of managing their capital adequacy
  • Central banks hold foreign exchange reserves on behalf of their government
  • Super funds that have a reasonable allocation to illiquid assets could hold government bonds to help them to meet redemptions quickly and easily

The sweeping arguments about government bonds don’t specify properly what segment of the market is being analysed. For example, the return quoted in Paul's article of 5.1% contrasted with the experience of some investors who achieved only 2% from the asset class in 2018.

It’s easy to guess how the return difference came about. These are the possibilities:

  • The return quoted in the article was from an ‘all maturities’ index. Investors in a fund that focuses on shorter term, lower duration bonds received a smaller return. For example, a fund limited to securities with maturity not longer than 10 years returned around 1% less than the 'all maturities' market. Shorter maturities were returned lesser. Further, deduct an active management fee and you could easily be as low as 2% for your return last year.

  • Another possibility is that some investors were in an actively-managed 'all maturities' fund in which the manager expected yields to rise during 2018 and so had positioned the fund in shorter term bonds. Such a strategy would miss a chunk of the capital gains on offer.

Owning ‘government bonds’ doesn’t, in itself, deliver the degree of diversification benefits claimed in Paul's essay. The portfolio needed a reasonable holding of longer-term bonds that enjoyed some capital gains. Short-term government bonds really only give downside protection. Of course, in a year in which domestic shares delivered a negative return, even +2% provided some ‘diversification’. But a corporate bond portfolio also did that with better returns over the medium to long term.

A couple of other comments on Paul’s article

Paul’s chart showed returns from global government bonds in 2018 of +13.7%. One comment correctly pointed out that this would have been from unhedged global bonds, therefore most of the return came from currency gains rather than from bonds as such. Currency is also a diversifier and may well be the better diversifier for Australian investors to rely on, than our own government bonds.

Another comment said Paul's argument only works when inflation is falling, claiming that this is why bond returns have been strong for 'the past 30 years'. I'll simply point out here that falling inflation led to lower bond yields which have reduced bond returns, not bolstered them. Lower yields deliver capital gains only in the short term, but ultimately bonds are all about income. The last 30-year period started with high yields and high returns, but that was because of high inflation in the 1970s, not because of falling inflation in the 1990s and since.

In any case, you don’t need to create stories about the macroenvironment to predict that Australian government bond returns will be low over the next several years at least. We know it from their yields. The 5- to 10-year Commonwealth bonds are now paying investors only around 2%. So, over the next 5-10 years, that will be their average annual return. If yields do rise, then those returns will gradually increase as well.

 

Warren Bird is Executive Director of Uniting Financial Services, a division of the Uniting Church (NSW & ACT). He has 30 years’ experience in fixed income investing. He also serves as an Independent Member of the GESB Investment Committee. These are Warren’s personal views and don’t necessarily reflect those of any organisation for which he works.

RELATED ARTICLES

One last hurrah for the 60/40 portfolio?

Why we believe bonds are now beautiful

Inflation? Nothing (much) to see here

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Latest Updates

Planning

Will young Australians be better off than their parents?

For much of Australia’s history, each new generation has been better off than the last: better jobs and incomes as well as improved living standards. A new report assesses whether this time may be different.

Superannuation

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Investment strategies

A steady road to getting rich

The latest lists of Australia’s wealthiest individuals show that while overall wealth has continued to rise, gains by individuals haven't been uniform. Many might have been better off adopting a simpler investment strategy.

Economy

Would a corporate tax cut boost productivity in Australia?

As inflation eases, the Albanese government is switching its focus to lifting Australia’s sluggish productivity. Can corporate tax cuts reboot growth - or are we chasing a theory that doesn’t quite work here?

Are V-shaped market recoveries becoming more frequent?

April’s sharp rebound may feel familiar, but are V-shaped recoveries really more common in the post-COVID world? A look at market history suggests otherwise and hints that a common bias might be skewing perceptions.

Investment strategies

Asset allocation in a world of riskier developed markets

Old distinctions between developed and emerging market bonds no longer hold true. At a time where true diversification matters more than ever, this has big ramifications for the way that portfolios should be constructed.

Investment strategies

Top 5 investment reads

As the July school holiday break nears, here are some investment classics to put onto your reading list. The books offer lessons in investment strategy, financial disasters, and mergers and acquisitions.

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.