Bonds aren't about to disappear. Here's why
Bonds aren’t about to go the way of the dinosaurs. The first bond-like products date as far back as 6th Century Mesopotamia, though the first-ever government bond was issued by the Bank of England in 1693.
The size of the industry, whose roots extend throughout the global financial system and the economies on which it is built, means sovereign bonds are here to stay. Adam Bowe, an executive vice president and portfolio manager at fixed-income fund manager PIMCO, said as much during a recent interview with Livewire Markets.
“Will the bond market still exist? Of course it will. The global bond market is an enormous place. It dwarfs the size of the global equity market and will continue to exist regardless of whether sovereigns have additional avenues for financing themselves at some point in the future,” he said.
That’s not to say fixed-income markets are static. Far from it. Bowe suggests what could change in future are the additional ways sovereign entities are financed as digital finance expands. And we’re also seeing changes in the way investors access the sector, including the rise of listed investment trusts (or listed investment vehicles) that provide transparent, alternative ways to add credit exposure to retail portfolios.
“That's an attractive, alternative way for non-institutional investors to generate consistency of income and access those more attractive areas of the bond market they might not otherwise be able to do,” Bowe said.
The availability of yield is also something that is constantly shifting, with investors still struggling to find sources of reliable income for their portfolios. This is something that struck Bowe as he travelled around Australia during PIMCO’s recent roadshow to promote the launch of its new listed investment trust, the PIMCO Global Income Opportunity Trust (ASX: PMX).
The opportunities are there, though. You just need to know where to look. In his recent interview, Bowe discussed which parts of the credit universe his team believes hold the best opportunities, and why. He also:
- scratched the surface of global geopolitical events, which continue to defy all forecasts (despite what the armchair experts might tell you).
- explained how PIMCO is positioned across interest-rate duration and credit asset classes, and why.
- discussed what the US Fed, and now the Bank of England, rate rises mean for other developed nations and how much is already priced-in.
Adam Bowe, PIMCO
Why are Australia, New Zealand attractive?
In the early part of the interview, Bowe explained why he regards Australian and New Zealand markets as more attractive than other parts of the world currently.
"Right now, we've got markets pricing in monetary policy moving back towards more normal levels of interest rates. And so from that starting point, you can certainly construct portfolios with some duration in these developed countries that provide that diversification to the riskier parts of your portfolio,” Bowe says.
The “buffering” effect of these country exposures in the face of potential further adverse economic effects gives him confidence in PIMCO’s performance outlook over the next couple of years.
“Pockets of the developed world such as Australia are already priced for neutral policy rates, and New Zealand is already pricing in restrictive policy rates. Those types of sovereign bond markets provide valuable tools to introduce diversity and safety that you would expect from core bond portfolios into broader asset portfolios,” Bowe says.
And on the topic of the fraught geopolitical environment – particularly the humanitarian disaster unfolding in Ukraine – he emphasises the importance of staying humble in the face of such unpredictable events. The war also highlights the importance of building resilient portfolios. How does PIMCO do that?
- By “stress testing” performance models
- Trying to ensure assets have cash flows that will hold up in all – or most – conceivable scenarios
- Looking for assets with consistent income, that won’t see big impairments during periods of heightened volatility.
Are bonds headed for extinction?
On the question of bond markets’ longevity, raised in controversial recent comments from fixed income fundie Vimal Gor, who suggested that sovereign bonds won’t exist 10 years from now, Bowe is dismissive.
The comments from Gor are probably unsurprising, given he recently quit a long-held role with Pendal Group to head up a “decentralised finance” team at crypto advisory firm Trovio.
“Will the global bond market still exist 10 years from now? Of course it will,” Bowe said.
“The global bond market is an enormous place. It dwarfs the size of the global equity market and will continue to exist regardless whether sovereigns have additional avenues for financing themselves at some point in the future”
But focusing on the here-and-now, Bowe is more concerned with how to build resilient portfolios that will continue to meet clients’ increasingly important (and elusive) yield requirements.
Finding yield is difficult, not impossible
How is his team doing that? It’s become more difficult for everyone, but not impossible.
In light of the inflation targets of markets in the US, Europe and here in the Asia Pacific, Bowe’s portfolios are running shorter duration exposures currently. And in seeking to benefit from some of the relative value in Australasia’s sovereign yield curve, he says New Zealand is attractive currently. That’s because the economy headed up by Prime Minister Jacinda Ardern is already priced for restrictive monetary policy, whereas many others don’t even reflect a neutral policy footing.
He also sees opportunities created by wider credit spreads in global bond markets. This is being spurred by the tragic events unfolding in Ukraine, prompting a renewed emphasis on markets such as Australia. The volatility, along with the winding up of the RBA’s Term Funding Facility in the middle of last year, means local banks have had to find alternate funding sources, including unsecured bonds and residential mortgage-backed securities that they were using previously.
“Those types of absolute yields (in senior unsecured assets) are becoming more attractive in portfolios for clients who are trying to generate that consistency of income,” Bowe says.
“And you compare that type of absolute yield to some of the other sources of income, like hybrids, that have been issued lately with spreads below 3%. So, there are certainly attractive pockets of the corporate market - we've been incrementally adding to the senior debt of banks and financials, both in Australia and globally.”
Why fixed income listed investment trusts are the future
Looking broader afield, how can retail investors get exposure to types of assets that generate healthy levels of real income, which are well-known to institutions but harder for mums-and-dads to buy?
“I think the most attractive way to do this is via listed investment trust products. Clients then have liquidity on the exchange through buying and selling units and it doesn't impact the liquidity of the underlying assets that we're investing in,” Bowe said.
“That's something we're getting more involved in over the coming months and years. That's an attractive alternative way for non-institutional investors to generate consistency of income and access those more attractive areas of the bond market they might not otherwise be able to do.”
This is a message Bowe and his team have been emphasising recently in their conversations with financial advisers and their clients, as they’ve been travelling around Australia during the PIMCO roadshow.
What’s the most notable thing he’s learned during these events? Undoubtedly, it’s the ongoing lack of income-providing assets for non-institutional Australian investors.
“If you cast your mind back maybe 10 years, Australians used a lot of term deposits for their income, and were able to earn nice positive returns after inflation or income after inflation just from cash and term deposits. Obviously, that has disappeared, and I don't think it's coming back,” Bowe said.
This shortage of income sources is further emphasised by the oversubscription of hybrid securities issuances in recent months.
“There’s so much non-institutional money in Australia chasing stability of income but they're not getting it. That's something that also isn't providing you with an income after inflation,” Bowe said.
“Headline inflation's running above 3% now. Talking to clients over the last couple of weeks, the overwhelming lack of options to generate consistent income above inflation was really apparent.”
Does the Fed hike pile pressure on the RBA?
And finally, Bowe addressed the US Fed’s 0.25% hike of official interest rates last week, its first since 2018. This was closely followed by a similar move from the Bank of England, and other developed markets are expected to follow in the months ahead.
These moves were well telegraphed, and markets have already been priced accordingly. The only question, in the eyes of Bowe and his team, is how quickly this new “normal” level for policy rates is achieved.
“In places like Australia, the central bank communication is a bit behind other central banks and still suggests it will be some time before they start to increase the cash rate here. The market is largely looking forward through that, though, and is already pricing a hiking cycle starting this year in Australia,” Bowe says.
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Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...