Over the past few months there has been a significant amount of press about a “global bond market rout”. While this topic is justified it is isolated to certain product types (i.e. fixed rate bonds), so what might seem risky to some is not risky to others. For this reason we believe it is critical for Australian income investors to understand the risks of different parts of the bond market and not to simply avoid all bonds on market headlines. The “bond market rout” or put simply a correction in bond yields is a function of three distinct things: normalisation of unconventional monetary policy, a pickup in inflation expectations and the sensitivity of your portfolio to changes in interest rates (otherwise known as duration). The first two factors have been driving performance across markets for a number of years but in reality have little to do with what is happening in Australia. The third factor is a choice for investors but traditionally large superannuation funds have used this as the defensive component of a portfolio as it was inversely correlated to equity performance. Unfortunately, duration has been creeping up over the past few years and will continue to do so as the Federal Government looks to fund future budget deficits. This increase in duration comes hand in hand with a ‘normalisation’ in bond market yields which together is not a defensive investment strategy. Therefore, we believe that investors should reconsider passive fixed income investment strategies and reduce their interest rate risk. Over the coming week we will release a report discussing the drivers behind this theme and question whether or not your bond portfolio is truly ready. We will cover:
- Are we at the end of the Bull Run for bonds? If so where to from here?
- Inflation and Unconventional Monetary Policy: How it effects your portfolio?
- Interest Rate Risk: Where we are now and where we are going?
- Interest Rate Risk: How to protect yourself?
- Index Tracking vs Direct. What is the difference? What is better? And why?
- Beware Bond Indices: Benchmarking against the largest creditors?