Just what is it about government bonds that Australian investors don’t like?
Despite having one of the largest pools of superannuation money on the planet, tipped to be more than $3.5 trillion in another 10 years, local investors have one of the lowest allocations in the world to bonds.
Ironically, sharemarket investors have snapped up any sort of share that remotely looks like a bond over the past few years as they value the regular dividends much like manna from heaven.
According to the Willis Towers Watson Global Pension Assets Survey of 2016, the average local pension portfolio has just 14 per cent of bonds in it.
That’s nothing compared with the average fund in the US which has 23 per cent in bonds and UK funds which have almost 40 per cent. Japanese investors love the regular income a bond pays and have almost 60 per cent in their portfolio, while Canadian investors make sure they have about one-third of their pension allocated to them.
It’s not as if bonds have been a bad investment over the past few years. Indeed, they have shot the lights out.
Positive returns
According to Pimco, a big player in the global bond market, over the past eight financial years, bond returns in Australia have beaten equity returns on average by about 2.5 percentage points each year.
During that time, the bond market posted positive returns for investors every single year while the sharemarket suffered falls of 20 per cent in 2009 and 7 per cent in 2012.
And looking ahead, there will be more of a need for bonds. Pimco’s Rob Mead says that since the global financial crisis, the number of Australians aged 65 and over has increased by more than 750,000, a rise of 27 per cent in just seven years.
“With this dramatic shift in demographics comes an important need for retirement income; given that the investment horizon is shorter, retirement income sources should generally obtain exposure to assets with lower levels of volatility,” he says.
The one big problem with bonds these days is their price. Their record low yields means record high prices, bond yields trade in the opposite direction to bond prices – and that is reason enough for some investors to steer clear of them.
Almost $US15 trillion ($19.43 trillion) of high-quality global government bonds are now trading with a negative yield, which means investors are happy to lock in a loss as soon as they buy those bonds. Reason enough not to buy them.
In fact, these days it’s the bond fund managers that are investing for capital growth and chasing those willing buyers of negative yields, while the equity fund managers are intent on investing for dividends and income.
Portfolio risk
In reality, yields on bonds have been falling since the early 1980s when bond yields peaked, providing stellar returns, about 6 per cent a year.
Analysts like Peter Jolly, global head of research at National Australia Bank, are telling clients that the bond rally is now over and it’s not the best time to buy bonds.
Put simply, he thinks that although inflation is low now, it will start to pick up in the years ahead and anyone buying a 10-year Australian government bond at its current yield of about 1.9 per cent is not being adequately rewarded for the risks they are taking.
But Andrew Cormack, portfolio manager at Western Asset, reminds investors it’s well known that including a bond allocation in an equity portfolio has greatly improved the portfolio risk and reward characteristics over the past 30 years.
“An investment split 30 per cent in equities and 70 per cent in bonds has produced a higher return than equities alone with approximately half the volatility,” he says.
“Some investors are concerned that bonds no longer provide adequate diversification to equity allocations. Western Asset believes bonds are still an attractive diversifier, especially during periods of flight to quality.”
