Bonds, property or equities: Which will come out on top in FY23?

Ally Selby

Livewire Markets

For years, the financial press - myself included - has spilt much ink on the woes of retirees and those reliant on the income generated by their investments. With rates heading lower, we journalists dedicated tens, if not hundreds of articles, to solving this income puzzle. 

As I am sure you are well aware, over the past decade, bonds and term deposits were traded in for investments like equities, managed funds, listed property investments, high-returning credit investments or god forbid, cryptocurrencies, as investors were "forced up the risk curve". Many were burnt chasing a "sure thing" in the process. 

Thanks to raging inflation - which is well-regarded as the kryptonite of markets - that has all changed. Central banks around the globe have lifted rates beyond zero, resulting in valuations diving across equities and yields exploding higher for bonds. 

So where does that leave Australia's asset classes (particularly favourites like REITs and equities), and does the outlook for fixed income markets (and the once-trusty term deposit) look sunny once again? 

To answer those questions, I sat down with three of the country's top income specialists - including the Godfather of structured credit Rob Camilleri of Realm Investment House, property powerhouse Pete Morrissey of Dexus Asset Management, and Australia's very own dividend doctor Dr Don Hamson of Plato Investment Management. 

They share what has them excited across each of their three asset classes as we enter a new era for income, the risks they foresee ahead, as well as my favourite segment of the interview, in which they name the asset class (and in which order) they believe will shoot the lights out over the financial year ahead. 

Note: This interview was recorded on Wednesday 31 August 2022. You can watch the video or read a written summary below. 

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The funds below are managed by the guests in this panel session. Click on the fund name to learn more about performance, process and fees.

Why you're being skimmed by the banks on term deposit rates...

Following the RBA's latest rate hike, investors can now access term deposits (TD) with seemingly "attractive" rates of anywhere between 3-4% over 12 months and 2 years. But Realm's Rob Camilleri believes investors are still losing out. 

"The average TD rate for a two-year return is around 3%, versus a bank bill swap rate which is about 4% for the same time period. You're losing about 80 basis points from the market," he said. 
"So in effect, the banks are borrowing really cheap from mum and dads through the TD market." 

However, even if investors can get a 3% or even 4% return on a TD, with inflation running at 6.1%, they are still losing money, Plato's Dr Don Hamson added. 

"If you lock in a 3% TD, you're going to go backwards 3%. So if you put a million dollars into a TD and you lose 3%, you lose $30,000. So to me, that's one of the big risks," he said. 

... And other risks to have on your radar

It's not just TDs that could burn investors over the months ahead. As Hamson explains, sometimes the worst stocks to be invested in are the highest yielders. 

"If its share price has fallen, higher yield usually indicates that they're going to cut their dividends," he said. 

"People are now speculating that might be happening in consumer discretionary. If interest rates go up and we have a recession, then that'll be the first thing that gets cut back." 

Meanwhile, Dexus Asset Management's Pete Morrissey warns that even as investors head back down the "risk curve" their capital could still be at risk. 

"There probably are going to appear to be some quite attractive headline yield numbers, but investors just really have to be clear of what the risks are associated with getting those levels of income," he said. 

Attractive opportunities remain as rates continue to rise

As Morrissey and other investors would know, FY22 was certainly an interesting year, particularly for REITs. 

"In the first half of the financial year, REITs outperformed over equities by 11%, and over calendar year '21 they were ahead by 9%," he said. 

In the second half, however, REITs - seen as a proxy for bonds - were significantly sold off as interest rates rose. In fact, since the beginning of 2022, the S&P/ASX 200 A-REIT Index has sold off more than 22%. 

"As markets most often do, there appears to be a significant level of overreaction," Morrissey adds. 

"Reporting season has shown investors that earnings are pretty stable. There's rental growth coming through to offset higher costs of debt. So I think the outlook is pretty reasonable going forward from here for REITs." 

Meanwhile, Hamson continues to back the miners and energy stocks over FY23. He argues that energy prices were rising long before the war in Ukraine, largely due to years of underinvestment in oil, gas and coal. 

"These companies are making huge amounts of money and I see that happening for a number of years. In 20 years, they may be dead, but they're going to make some good money in the next 10 years," Hamson said. 

"BHP has a small mining operation. Last year or the year before actually it made US$288 million out of coal. This last financial year it made US$9.5 billion. It's a huge turnaround." 

For Camilleri, the areas he's avoiding are more important than those where he is putting money to work.

"We've seen traditional bond funds underperform dramatically, even worse than the GFC. The All Maturities Index is down 15%... [with] long duration and interest rates selling off," he said. 

"So that's definitely not a place that we are excited about." 

Instead, he's focused on short-duration, credit-like investments, as if inflation remains "sticky" and cash rates reprice further, "bond markets aren't going to do well". 

"So being short, floating, so you're indexed with higher rates as they come through, we think that's the safe place to be," Camilleri adds. 

Is the era of cheap money and low inflation over? 

With Federal Reserve chair Jerome Powell sticking to his hawkish interest rate stance, and US 10 Year Treasuries still sitting at around 3.3% (having peaked slightly higher at around 3.5% in June), the market remains divided on the future path of interest rates (and what this means for markets). 

With this in mind, Hamson believes the era of uber-cheap money is over. 

"We're probably not going to see 0.1% rates here in Australia ever again," he said. 
"I think the cycle might be now 1.5% to 4% - looks like about 4% where people think interest rates are going to peak. But that's actually still relatively cheap as far as history goes." 

Morrissey agrees. 

"The global pandemic was so significant we got torn one way and it was a massive, perhaps you'd say over-correction, to try and deal with what was an unknown event," he adds. 

"You've got to pay the piper at some point in time and so I'd say inflation, clearly, is going to overreact in the other direction as well, and then we'll get to a point where we're at a level of normalised stability. But there might be a bit of volatility in between in getting to that point." 

So is this the new normal? Well, Camilleri argues that after years below the RBA's 2-3% CPI target, investors should expect above-target inflation for quite some time. 

"We spent a decade under the band, so some people call that abnormal or weird," he said. 

"As we reprice, as rates go up, inflation's probably going to spend a lot of time above the band. That could be quite normal, because when you look at it over a 20 or 30-year period, it all averages out in that band.

"So is it a new era or abnormal? Probably not. I think we're readjusting some imbalances that have come through because of the pandemic. That's going to take time to wash through." 

Equities, property or bonds: Which asset class will come out on top in FY23

We put this question to the fund managers featured in this panel session and asked them to rank the performance of these three asset classes over the financial year ahead. 

While, yes, naysayers may argue that they are clearly advocating for their own asset class and talking their own book, they actually provide some deeper insights into where they are finding value within their investment universes right now. 

For instance, Camilleri argued that floating fixed income investments with strong running yields could produce returns in the mid to high single digits, which is consistent with returns from the Realm Strategic Income Fund. This is pretty attractive, given the S&P/ASX 200 is down more than 9% year to date (and REITs, as mentioned earlier, are down 22%). 

With this in mind, he ranks property and equities as a close second. 

Meanwhile, Morrissey who manages the APN AREIT Fund believes this very sell-off that we have witnessed in REITs of late could result in an impressive turnaround in the asset class over the year ahead, ranking his area of the market first, followed by equities and in last place, bonds. 

"A lot of names are trading at 20% plus discounts to NTA, so there's no value ascribed to some of these names around really long term businesses," he said. 

"I think the recognition of the broader market will be there. We saw that in July when there was a really strong recovery in REITs... I think through the back end of next year and the second half of FY23, there'll be some solid returns coming through." 

And while Australia's dividend doctor believes that equities will outperform in FY23, he caveats that by arguing that growth stocks will continue to struggle. Instead, he's backing the Value end of the market in the Plato Australian Shares Income Fund, as well as sectors like energy that can continue to lift prices in a rising rate environment.

Interestingly, he ranks bonds in second place.  

"Because of their leverage, I think REITs would actually be my number three," Hamson said. 

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Ally Selby
Deputy Managing Editor
Livewire Markets

Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...

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