Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 84

Your bond questions answered

Warren Bird’s previous article, An idiot’s guide to bond funds, was written in response to a message from James, a Cuffelinks reader, who asked for an explanation of bonds in layman’s terms. This article wraps up the series, addressing the remainder of James’ questions.

Should one invest in bonds for income or capital gain?

Bond returns are income returns over time; you can speculate about short term market movements if you want, and try to time your entry to achieve capital gains, but the nature of bonds and bond funds is income returns.

Are there some bond funds that should be included in the growth section of a portfolio as opposed to the defensive?

Funds that invest in lower rated corporate bonds and high yield are more closely correlated with equity market returns and thus don't perform the same defensive role as a portfolio of Australian government bonds. But they still aren't 'growth funds' so they don't belong there. Some funds have a category for 'middle risk' or 'alternative defensive' assets that they put credit and high yield into.

Is a 70/30 split crazy when interest rates are at all time lows?

Not in my view. The concern seems to be that bonds will perform poorly when rates go up. However, just because rates are low doesn't mean they are going to go up significantly; even if they do, it means your expected future returns will ratchet up as rates go up. And equities are pretty fully valued so it's quite possible that they will fall sharply when bond rates go up.

What are the merits of passive vs active investing in bonds (it is my understanding that most bond funds have underperformed passive funds over the past ten years, much like active equities funds)?

It's not true that most bond funds have underperformed - in fact, most have outperformed passive funds. The issue for many super funds, etc is that the amount of outperformance from bonds is much less than in other asset classes, so they would rather allocate fees to seeking higher excess returns than bond managers can deliver. I think you should focus on after-fee returns and if you can get value add from any asset class you should be willing to pay for it.

Please explain these new-fangled ‘unconstrained bond funds’.

The gist is that they are funds that try to get value out of trading short term views of bond markets and sometimes equity markets, too. The specific strategies are unique to each fund and the skill set of the managers on their team.

Are they just a fad?

I gave a short response to this very question in the comments section of this piece, What’s that UBS bond benchmark in the annual statements?. I personally invest in them so I don't think they are a fad. They have a place in the risk-return spectrum.

Are they a genuine solution to the duration risk argument?

That's not the reason I would invest in them. Duration risk is worth taking - with positively sloped yield curves you get paid to take duration risk.

Have they been created in response to bond fund managers wondering where the next dollar will come from after a 30 year bull market?

No doubt that was the motivation for some of them, but since most of them were developed several years ago before talk of 'the end of the 30 year bull market' took hold, it's probably not true for the sector as a whole. A less pejorative view is that end-investor demand for more income-focussed products that weren't constrained to just bonds led to products being developed to meet that demand. I personally think that funds with duration have a place in many portfolios and I have some in my own SMSF.

 

Warren Bird was Co-Head of Global Fixed Interest and Credit at Colonial First State Global Asset Management. His roles now include consulting, serving as an External Member of the GESB Board Investment Committee and writing on fixed interest. His comments are general in nature and readers should seek their own professional advice before making any financial decisions.

 


 

Leave a Comment:

RELATED ARTICLES

Busting the bond myth

Stars align for fixed income

How gold can help diversify your portfolio

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

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.