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

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.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

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.