Jamieson Coote Bonds are becoming more aware of the causes that lead to many Australian investors losing a large portion of their retirement savings during the last GFC. Some of this can be linked to a lack of diversification, a large bias to long-only equities, and in many cases, little to no exposure to true-to-label defensive fixed income. As such, these investors, without this exposure, did not experience the portfolio protection that such an allocation provides alongside an equities allocation.
Many commentators love to criticise bonds as dangerous and often point out extreme scenarios of "normalisation". Of course, they just happen to omit that "normalisation" also extends to property and equities who have been a large beneficiary of lower funding and discount rate assumptions.
In doing this they pick a high duration bond and shock the valuations back to levels not seen for many years, again without reference to what that actually means for an economy and equity valuations - that significantly higher cost of capital leads to recession. This isolation of only one bond amongst a vast array of bond securities is as misleading as picking a particular equity stock on the ASX and showcasing all equity returns based off the performance of one highly sensitive company. Don't be fooled by this cheap sales trick.
For instance, in 2016, Australia issued its first 30 year Government Bond which sold off post the US election in exactly the manner described by such commentators. And yet despite that isolated move a portfolio of government bond securities (of various durations) still produced positive returns in excess of RBA cash over the year.
Demand for Australian Government Bonds is at record highs
Buyers of a recent $11Bn issue included global sovereign wealth funds, pension funds, asset managers and central banks seeing no apparent jitters that many equity managers may tell the media. These sophisticated investors see the value of such product in a diversified portfolio in such times of uncertainty.
As most have seen via the press overnight, the AOFM just issued a record $11Bn of Australian Government Bonds that has attracted approximately $20Bn of demand in 24hours.
A couple of quotes from Westpac and ANZ currency and interest rates strategists in a national newspaper** today illustrate the demand for Australian government bonds from some of the most sophisticated investors on the globe:
“It seems a positive story overall … no apparent jitters over AAA and foreigners aren’t waiting for better levels to buy. Given support for iron ore and coal prices, they may not get better levels.” said Sean Callow, currency strategist at Westpac. ANZ senior interest rate strategist Martin Whetton said the deal drew a record value of bids worth more than $20bn and was it executed at the tighter end of the AOFM’s range. “The fact that they also issued that December 2021 issue in January and they’ve come back to the market in a month and got a record amount is just quite a testament to the market demand for Australian dollar bonds. It’s certainly not the case that they are issuing too cheaply” **
Why hold a portfolio of bonds?
Bond investors do not normally hold a portfolio of securities for absolute returns (like equities which are a growth asset class). Bond investors hold a portfolio of securities for portfolio insurance and ballast. Bond holdings will behave differently over time and insulate a portfolio during times that equities experience significant stress (such as the GFC).
In the years after a pullback in bond markets their powerful self correction is evident: Post sell off of 1994 they produced 18.8%, 11.9% and 12.5% in 1995-1997. After 1999 returns are 12.5%, 4.5% and 9.2% in 2000-2002. In the GFC Australian Government
Bonds show the benefit of negative correlation with circa +20% returns whilst equities lost over 40%. In 2009 bonds had a slight pullback with a small negative return but go on to post 5.2%, 13.4% and 5.5% in 2010-2012.
Historically any significant pullbacks (in a relative sense) have been great times to build an allocation to defensive products such as a portfolio of Australian Government Bond securities.
Looking ahead, JCB believes that interest rates will consolidate in a range as global debt burdens contain such “normalisation”. We foresee a period of consolidation in interest rate markets with higher yields providing more income for investors. Historically after a long and powerful trend, markets do not easily reverse without forming a base for a number of years. President Trump cannot change structural issues of highest ever global debt burdens which require low interest rates to service increased leverage, demographics continuing to drag on economies in the western world and technology continuing to provide lower cost (disinflationary) outcomes for consumers.
The RBA look firmly on hold over 2017 and historically that has always been a precursor for positive bond returns. As a defensive allocation that can slingshot in times of geopolitical or market stress, an active portfolio in Australian Government Bonds look set to continue to play a critical defensive role for diversified portfolios. Australian Government Bonds rarely have negative returns. They are a low risk asset class, with investment principle and coupon cash flow guaranteed by the government. Modern day portfolio theory recognises the critical defensive role they play in a diversified portfolio providing unparalleled liquidity (far better than Term Deposits), capital stability, and government guaranteed cash flows providing regular income (unlike complex bank risk within hybrids). The pullback of Q4 2016 provides solid footing for Australian Government Bonds looking forward.
JCB firmly believe in diversification across equities, equity income, real assets, alternatives and fixed income. We encourage advisors and investors alike to challenge their historical asset allocations by continuing their search for diversification with quality specialist asset managers who can generate alpha (outperformance) in various asset classes, particularly going in to what most global money managers consider to be a future of uncertainty.
**The Australian, AOFM in record $11bn bond deal, David Rogers Markets Editor Feb 22 2016
Angus established Jamieson Coote Bonds with Charlie Jamieson in 2014. He started his career with JPMorgan in London, before working at ANZ and Westpac, where he transacted the first ever Australian Bond trades for several large Asian Central Banks.