Fixed Income

Markets recoiled last week with increased US tariffs on Chinese goods increasing the all-out risk of a global trade war, where growth slows and just about everyone else loses.

Well-known commentator Marcus Padley declared on ABC News Breakfast that he had moved 47 per cent of his portfolio to cash, but cash isn’t the only “safe haven” investment.

Low-risk Australian government and senior major bank bonds outperformed during the GFC and are considered “safe haven” investments. Investors switched from shares to low-risk bonds and higher demand, among other factors, contributed to higher bond prices when prices of most other investments were declining rapidly.

When the market turns, investors are less concerned with returns and more concerned with protecting capital. Bonds have a maturity date where the government or company that issues the bonds promises to return capital, providing tremendous certainty and protecting your portfolio.

Readily available cash is still king but keeping 100 per cent of your defensive allocation in an “at call” account will be a drag on overall returns. If you are looking for an investment that has similar defensive characteristics but better returns, then bonds are worth exploring.

Every investor should have cash in their portfolio — my argument is you could hold less and invest a portion in low-risk bonds for better returns from your defensive allocation with the potential to outperform expectations.

In terms of risk, bonds are the next best investment on the risk spectrum. Historically, returns of investment grade corporate bonds have been 1-2 per cent a year higher, but like other asset classes returns have compressed in this low-rate environment.

On the face of it, Australian government bonds returns are impossibly low. The 10-year government bond rate is just 0.94 per cent per annum and has been declining rapidly. Lower yields on these fixed rate bonds means the prices have been rising, delivering higher than expected returns to investors if they decide to sell prior to maturity.

Switzerland, Germany and Japan are some of the countries that have negative yields on 10-year government bonds. If you think 10-year Australian government bonds might join them, you would invest with the expectation that as yields decline, the bond prices will rise.

Only a handful of corporate bonds and a selection of government bonds are traded on the ASX. The vast majority of bonds are traded in the over-the-counter market, where you need to find a broker to transact.

The XTB Australian Corporate Bond Company has made over-the-counter corporate bonds available on the ASX in a trust format since 2015, including senior major bank bonds. Quoted major bank XTBs show income of 1.75 per cent to 2.13 per cent and investors can buy bonds for as little as $500 per bond.

Investors with larger sums to invest can seek dealers who will trade in the wholesale market where the minimum is $500,000 per bond. Some specialist dealers will split $500,000 parcels into smaller amounts from $10,000.

Bond prices and returns are changing rapidly. You will need to consult a bond broker for the latest yields or check the price of government bonds and senior major bank bonds (XTBs) listed on the ASX.

Bonds have many similar characteristics to cash:

1. Investors know the expected returns when they invest. Fixed-rate bonds will pay an absolute return, giving investors who need the cash flow great certainty. Floating-rate and inflation-linked bonds have variable returns but include a fixed-rate component above a floating benchmark.

2. Like term deposits, bonds have a maturity date. Direct investors never have to worry about making the decision to sell, which can be a huge benefit to individuals worried about leaving the finances to spouses who are not interested in financial markets.

3. Most Australians are confident in the four major banks. These banks along with other financial institutions, where you may already hold deposits, also issue bonds.

One important benefit, which is not available with term deposits, is that bonds are tradeable and if you need to sell government or senior bank bonds before maturity you can usually sell quickly.

Please speak to your financial adviser before making any changes to your portfolio.

As published in The Australian on 13 August 2019

elizabeth@moranconsults.com




Comments

Please sign in to comment on this wire.

Harry

Elizabeth , Whats 3.01 % after tax ? Whats the dividend from banks and e.g. Telstra on the basis that you are using a 10 year scenario? In my humble opinion its a typical response to any dip in the market bearing in mind that "trade wars" are minor concerns but real wars are major concerns. Current interest rates of 1.0% on deposit is pretty close to or is negative after inflation. End up like Europe basically giving away your money to governments by investing in paper or deposits....crazy!

Mr T

elizabeth, I yearn for the day when FIIG or someone similar sets up an AUD 'bond management trust' (essentially identical to the ubiquitous Macquarie CMT but with investments in high grade bonds). I have talked to tiny investors, fund managers, UHNW family office members - and interestingly, all of us have the same problems and want the same thing (ie t+2 access to cash, low/zero transaction costs, a slightly better than bank deposit rate yield, only a little bit of risk for what is essentially our 'pile of cash', and the ability to transfer large $ amounts easily). This product doesn't exist in the market - but clearly could and should. i think the first company to bring it to market will do well... [for punters, funds, UHNWs - the universal experience is that direct investment into high grade bonds as a cash replacement is just a bit too clumsy to work well. (for example, many investment opportunities open and close within a 24hr period, but bonds might take a week to sell). so we end up holding a lot more cash than we want to. It is borderline comical seeing how some otherwise very sophisticated investors manage their cash float - because there just isn't a good australian solution.