Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 336

Have bonds reached the end of the line?

Bond markets typically perform well during periods of economic uncertainty. All else being equal, decelerating economic growth dampens inflationary pressures, increases the probability of interest rates heading lower.

That has certainly been the case over the last year or so. Economic conditions have softened both within Australia and offshore, and policymakers are debating whether further cuts are warranted.

The deteriorating economic background has been reflected in the local fixed income market. Yields on 10-year Commonwealth Government Securities have more than halved over the past 12 months, from over 2.70% in November 2018 to around 1.20% today. Remember, there’s an inverse correlation between bond yields and prices; the sharp move lower in yields has resulted in favourable returns from fixed income portfolios.

So far so good, but what now?

That’s great for investors who’ve had exposure to bonds recently, but what does it mean for the outlook going forward? Investors are increasingly questioning whether it might be time to lock in gains and remove allocations to fixed income investments. Official interest rates are negative in Europe and Japan and are being lowered elsewhere, most notably in the US. Moreover, increasingly accommodative policy settings by global central banks have driven yields below zero on more than a quarter of government bonds on issue worldwide. How much lower can they go?

It is understandable that investors are questioning whether bonds still have a role to play in portfolios.

In our view, they certainly do. In the interests of full disclosure, First Sentier Investors currently manages more than $15 billion of Australian fixed income securities, so our view probably won’t surprise too many people. But, even after putting unintended biases to one side, there remains a clear case to support ongoing allocations to defensive, income-oriented investments like bonds.

The asset class has an important role to play in most well-balanced, diversified portfolios, even though the future return profile is less appealing than it has been in the past.

The historical reasons for holding bonds include:

1. The low-risk profile 

Even though the overall indebtedness of most countries is increasing worldwide, the risk of default on debt issued by sovereigns in their own currency remains extremely low. Currently, Australian government debt is rated AAA by Moody’s, the maximum possible rating and one that’s only awarded to a handful of issuers worldwide. With the ability to print currency if required to meet debt repayment obligations, the likelihood of non-payment is very low.

2. A reliable source of income

Again, almost all bond issuers – including both governments and companies – are well placed to service their debt-servicing obligations and make regular coupon payments to investors.

While some global bonds are now showing negative yields to maturity, Australian government bonds still offer positive and secure income for investors. Most securities make coupon payments semi-annually. Yields and potential income are higher in corporate debt markets but with an inherently higher risk profile. With interest rates so low, most companies are currently able to comfortably meet their debt repayment obligations and profitability is holding up quite well among high quality firms. Accordingly, while the risk profile of corporate debt is always evolving, credit markets continue to offer opportunities for income-based returns with a relatively low risk of capital loss.

3. A hedge against falls in equities

Allocations to fixed income securities have historically helped preserve capital during equity down markets, effectively providing a cushion against falling share prices.

Even with yields below zero in some regions, the historical negative correlation between equities and bonds during periods of equity market stress is expected to persist worldwide. During times of elevated uncertainty, a ‘flight to quality’ into defensive assets with perceived capital security and plentiful liquidity would be anticipated, helping to maintain the historical relationship between equities and bonds.

Scope for capital appreciation from Australian bonds

If cash rates are lowered further in 2020, government bond yields could conceivably come under further downward pressure. This would push prices higher, augmenting income from coupon payments and lifting total returns. With yields at ~1.20% instead of ~2.70%, the expected return profile of Australian bonds is clearly lower than it was a year ago.

But, importantly, all of the above characteristics are likely to hold over the medium term, underlining the ongoing appeal of bonds as part of a broader asset allocation mix.

 

Stephen Cooper is Head of Australian Fixed Income at First Sentier Investors, a sponsor of Firstlinks. This article is for general information only and does not consider the circumstances of any individual.

For more articles and papers from First Sentier Investors, please click here.

 


 

Leave a Comment:

RELATED ARTICLES

The time for bonds has come

Is this the start of a generational bear market in bonds?

Investors need to look beyond bonds for safety

banner

Most viewed in recent weeks

Are term deposits attractive right now?

If you’re like me, you may have put money into term deposits over the past year and it’s time to decide whether to roll them over or look elsewhere. Here are the pros and cons of cash versus other assets right now.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

How retiree spending plummets as we age

There's been little debate on how spending changes as people progress through retirement. Yet, it's a critical issue as it can have a significant impact on the level of savings required at the point of retirement.

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

Latest Updates

Property

Financial pathways to buying a home require planning

In the six months of my battle with brain cancer, one part of financial markets has fascinated me, and it’s probably not what you think. What's led the pages of my reading is real estate, especially residential.

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

Economy

Household spending falls as higher costs bite

Shoppers are cutting back spending at supermarkets, gyms, and bakeries to cope with soaring insurance and education costs as household spending continues to slump. Renters especially are feeling the pinch.

Shares

Who gets the gold stars this bank reporting season?

The recent bank reporting season saw all the major banks report solid results, large share buybacks, and very low bad debts. Here's a look at the main themes from the results, and the winners and losers.

Shares

Small caps v large caps: Don’t be penny wise but pound foolish

What is the catalyst for smalls caps to start outperforming their larger counterparts? Cheap relative valuation is bullish though it isn't a catalyst, so what else could drive a long-awaited turnaround?

Financial planning

Estate planning made simple, Part II

'Putting your affairs in order' is a term that is commonly used when people are approaching the end of their life. It is not as easy as it sounds, though it should not overwhelming, or consume all of your spare time.

Financial planning

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Sponsors

Alliances

© 2024 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.