Aussie bonds: when boring is good

Quite where you think the opportunity and outlook for bonds is slightly depends on what part of the sector you are talking about. Take a look at some Australian funds in this area to see how widely returns can vary in the debt markets. Australian fixed income funds have generally had a happy time of it recently, with the median fund returning 13% in 2008, according to Mercer Investment Consulting. (Curiously, index funds have actually done much better: the median has returned 14.5%. In fact, there is only one active fund in the whole of Mercer’s survey – a UBS bond fund – that has beaten the Macquarie True Index Australian Fixed Interest fund’s entirely passive 14.9% return for 2008.) But compare this with the experience of some of the funds which have focused on corporate debt, and in particular those that have gone for the riskier end of the spectrum. The Challenger High Yield Fund lost 29.1% in 2008, almost all of it in the last few months of the year. Challenger’s explanation to unitholders called 2008 “arguably the most tumultuous year ever for credit markets.”  And while the Challenger story was extreme, other Aussie funds in this area that lost money in 2008 included products from Aviva, Colonial First State and Credit Suisse Asset Management.

There are also products known as short duration high income funds, which invest in short-dated bond-like products. These had a torrid time in 2008, with products from BlackRock, Credit Suisse, Putnam and Principal all losing around 30% over the course of 2008, according to Mercer.

In international bond funds there is a similarly fragmented pattern. If we take the currency out of the picture (a big consideration for anyone wanting to invest in international bond funds) and look only at hedged funds, which use derivatives to neutralise currency movements, there are big differences in the results of bond funds according to the approach they took. The median sovereign bond fund, which means a fund that invests in bonds issued by governments, was up an impressive 12.7% in 2008. But the median of what Mercer calls “broad/aggregate” funds – those that invest in a wider range of bond securities – was down 4.1%, with products sold in Australia from AMP Capital and Perennial both down more than 10%. Again, funds that went for high yield internationally did worse still: Credit Suisse Asset Management’s high yield bond fund lost 29.2% and products from Colonial First State, Goldman Sachs JBWere and Legg Mason all plunged more than 10% apiece.

So where’s the right place to be? Michel argues that since global economic growth will, at best, be flat for the rest of 2009, with rising unemployment, there is likely to be continued accommodative monetary policy, and probably further rate cuts in Australia. “This environment should generally support the bond market,” he says. “However, a word of caution: the combination of historically low bond yields and a re-emergence of bond supply from governments will provide headwinds for a sustained rally… Much of the performance from bonds is now behind us.”

But Craig Keary, head of sales and distribution for Westpac Institutional Bank, thinks bonds almost represent “a new and emerging asset class” in terms of the renewed interest they are likely to attract. “Investors have to park their money somewhere, and the money they get on deposit may not be attractive enough and consistent with their long term investment strategy.” Specifically, he thinks “rated, corporate debt that is liquid” is the place to be: particularly securities that are traded on an exchange.

He points to the increasing number of issues that are coming out of Australian institutions in which ordinary people can participate. Take, for example, the issue of debt securities by AMP on March 3: they are 10-year securities with a five year call option (which means that, after five years, AMP can decide to redeem them and pay you back; if it doesn’t, the rate of interest increases afterwards). They are floating rate, which means they will pay a certain margin over a reference (in this case the Australian 90-day bank bill swap rate), and at launch you would expect them to start out paying 7.5 to 8% a year, or 4% or so above the cash rate. You only need A$5000 to buy them, much lower than bonds that are launched without a prospectus. Note, though, that these are subordinated securities: that means if AMP goes to the wall one day, the senior debt holders will get their money back before you. Another big issuer, Westpac, recently launched a hybrid bond that retail investors can participate in.