INVESTING in bonds is challenging in the current economic environment, with inflation and interest rates rising around the world.
But portfolios need diversification — and for investors putting money into fixed income assets, Australian bonds are an attractive option.
That’s because inflation and the prospect of interest rate rises are lower in Australia than the United States.
“If you are constructing a portfolio right now, bonds have relatively low yields and you’re seeing a spike in inflation,” says Michael Blayney, who heads up Pendal’s multi-asset team.
“In the US it’s 7 per cent year-on-year, it’s about 5 per cent in the UK and it’s 3.5 per cent in Australia. That makes it hard to be positive about bonds.”
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So is there any reason for investors to consider being overweight bonds?
“One big reason is geopolitical risk,” says Blayney (pictured above).
If Russia invades Ukraine — it has more than 100,000 troops amassed near the border — bonds would likely benefit from a “flight to quality”.
“US Treasuries would be a pretty good place to be in that case,” Blayney says. “But that would be a short, sharp event, so if an adviser is thinking more strategically, the bigger issue is inflation.”
Inflation is among the biggest risk facing retirees.
“It erodes a retiree’s purchasing power, and they are no longer earning wages,” Blayney says.
“Higher inflation is also generally bad for other asset prices, such as equities, because it causes bond yields to rise and that raises questions over the lofty valuations of some stocks.
“But the reality is that in a portfolio today you have to position yourself to have some hedges against inflation,” he says.
Returns on cash are almost zero so most investors still need to hold bonds. The question is how overweight or underweight they want to be in the bond market.
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“Whatever their position, investors need to look at what bonds look more attractive,” he says.
That’s where the Australian bond market stands out because the inflation outlook isn’t as severe as many other economies.
“I can buy a German bund [bond] and for the first time in quite a while get a positive yield, but it’s only 0.2 per cent. I can go to the US and get 1.9 per cent, but inflation is seven per cent and I’m reasonably confident that the Fed will hikes rates this year.
“I can go to Australia where I get about two per cent on a ten-year bond, and the inflation rate is much lower. And when the immigration tap turns on again, I know that will relieve some of the pressure on wages, which feeds through to interest rates.
“So, if you want to hold bonds, and balanced portfolios do even if they are under-weight, Aussie bonds aren’t a bad place to be,” Blayney says.
Michael Blayney leads Pendal’s multi-asset team. Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
The team — which also includes Allan Polley — manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.
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