Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 174

Five things bond investors are doing now

There has always been two easy ways for bond investors to increase returns: by investing for longer terms or by increasing risk by moving down the credit rating spectrum. While both of these options remain popular, here are some trends among bond investors at the moment.

1. Supply is down and fewer investors are selling

Not long ago, we had access to plenty of bonds and could readily find sellers in the market. Over the last few months, we've seen a number of forces at play including:

  • the RBA cutting the cash rate to 1.5% and investors realising interest rates will be much lower for much longer
  • a number of favoured bonds have matured, putting cash in investors' pockets, much of which went back into buying other bonds
  • limited new supply of corporate, non-financial bonds in Australian dollars - domestic issuance is low with many corporations issuing into the US market or reluctant to take on more debt.

Combined, all of these factors have cut supply. We've seen growing appetite for bonds, and while they can still be found, investors may need to wait a week or two to have their orders filled.

2. If they are selling, it’s inflation-linked bonds and cyclical resource bonds

Low inflation and rebounding resource prices have prompted sales of some holdings.

The outlook for inflation is low, in line with low growth rates. Headline inflation for the June 2016 quarter was 0.4% and trimmed mean for the past year 1.7%, lower than the Reserve Bank Board target range of 2% to 3%. Lower inflation results in lower growth in capital indexed bonds and lower income compared to a higher inflationary environment.

Theoretically, the global stimulus should work to increase inflation and we still view this as a risk worth protecting against. Two favoured inflation-linked bonds are seeing some turnover: Australian Gas Networks (previously Envestra) has a capital index bond maturing in 2025 with a yield over inflation of 2.87% per annum and Sydney Airport, a similar bond maturing in 2030 with a yield over inflation of 3.23% per annum. Even if inflation drops to zero or is negative, these fixed yields will help maintain a positive return.

The strong performance in resource bonds since Christmas – for example Fortescue Metals Group USD bonds are up between 30 and 80% - has seen some investors take profit and invest in other bonds that they consider have a better potential to outperform.

3. Diverging groups - one preferring investment grade, the other high yield

There has been a clear split in strategy, generally between institutional and private investors.

In Australia, institutional and middle market clients are often bound by mandates that restrict investment to certain minimum investment grade ratings for maximum terms. They are natural buyers of high grade bonds, with recent additional emphasis on quality. These investors also look for bonds that have stand out returns. A few months ago, we saw good institutional buying of a highly rated AUD Swiss Re old style hybrid paying 4.25% which we expect will be called in May 2017.

High yield bonds help deliver much needed income to SMSFs in drawdown and it’s perhaps natural that they would seek additional risk in this market. Our suggestion to anyone with this strategy has been to adopt a more equity-like approach and invest smaller amounts so that if any company gets into difficulty, then it has much less impact on the overall portfolio.

4. Buying longer dated, fixed rate bonds – investors don’t mind adding duration

Earlier this year, investors thought we had hit the bottom of the interest rate cycle and adopted a short duration strategy to prevent losses on long dated fixed rate bonds should interest rates rise. The thinking has shifted and they're now comfortable investing for much longer for better returns.

(Note: Duration is a measure of the price sensitivity of a bond to interest rate movements. Typically, duration provides an estimate of how a bond will change in price for a 100 basis point or a 1% movement in interest rates. For example, say interest rates change by 1% then a $100,000 par value bond with a six-year modified duration could expect a corresponding 6% change in its price, that is 1% x 6 years = 6% change. If the traded yield on that security moved up by 1% the next trading day, then the market value of that bond would fall roughly 6% from $100,000 to $94,000. Alternatively, if the traded yield on that security declined by 1% the next trading day, then the market value of the bond would rise by 6% to $106,000).

Long-dated, fixed rate bonds of ten years or more are growing in popularity. For example, gold miner Newcrest has a US dollar bond maturing in 2041 paying a yield to maturity (YTM) of 5.35% per annum and Canadian diversified power producer, TransAlta has a bond maturing in 2040 with a YTM of 6.91% per annum. Both of these bonds are investment grade rated BBB-.

5. Adding USD and GBP bonds to their portfolios

A growing trend has been the addition of foreign currency bonds especially with those investors who hold foreign currency deposit accounts or who have assets in other countries. The strategy also provides a hedge against the depreciation of the Australian dollar and allows wholesale investors to access a very broad range of companies and other entities, adding further diversification to their portfolios.

Recent popular targets have been BHP Billiton in USD and GBP, and others, mainly in USD - Newcastle Coal Investment Group, IAMGOLD and the latest addition is a range of bonds from information technology producer, Dell Technologies. The yield to call for these bonds range from 4.62% p.a. for the BHP Billiton USD subordinated bond with a first call in 2025, to the Newcastle Coal bond maturing in 2027 with a yield to call of approximately 10.5% p.a.

Note: Prices quoted are accurate as at 8 September 2016 but subject to change.

 

Elizabeth Moran is Director of Client Education and Research at FIIG Securities, a sponsor of Cuffelinks. This article is general information and does not consider the circumstances of any individual.

 

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Latest Updates

Investment strategies

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Planning

Super, death and taxes – time to rethink your estate plans?

The $3 million super tax has many rethinking their super strategies, especially issues of wealth transfer on death. This reviews the taxes on super benefits and offers investment alternatives.

Taxation

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Shares

The megatrend you simply cannot ignore

Markets are reassessing the impact of AI, with initial euphoria giving way to growing scepticism. This shift is evident in the performance of ASX-listed AI beneficiaries, creating potential opportunities.

Gold

Is this the real reason for gold's surge past $3,000?

Concerns over the US fiscal position seem to have overtaken geopolitics and interest rates as the biggest tailwind for gold prices. Even if a debt crisis doesn't seem likely, there could be more support on the way.

Exchange traded products

Is now the time to invest in small caps?

With further RBA rate cuts forecast this year, small caps may be key beneficiaries. There are quality small cap LICs and LITs trading at discounts to net assets, offering opportunities for astute investors.

Strategy

Welcome to the grey war

Forget speculation about a future US-China conflict - it's already happening. Through cyberwarfare and propaganda, China is waging a grey war designed to weaken democracies without firing a single shot.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.