By Gaby Rosenberg, Co-Founder, Blossom
In a remarkable shift, Australian investors are rewriting the playbook, turning their attention to bonds over equities.
As the financial landscape sees continued volatility, prudent investors are seeking new and different strategies to diversify their portfolios and safeguard their investments. Bonds have emerged as a compelling choice, offering lower risk, reduced volatility, and stable returns. In fact, in the past two and a half years, we’ve seen a 17% increase in high net worth individuals choosing to invest for guaranteed returns according to the (ASX Investor Study).
Australian households and institutions are re-evaluating their asset allocations, moving away from the allure of riskier equities, and embracing the appeal of higher-yielding fixed income and cash.
This convergence of equity and bond yields comes on the heels of central banks’ coordinated tightening. Inflation concerns have spurred a rush towards more secure investments, making the inclusion of bonds an attractive proposition for financial growth and stability.
In this article, we explore this shift, how bonds work and how they can enhance your portfolio.
Understanding Australian Bonds
An important point to understand is that fixed income is a defensive asset class. Fixed income investments offer fixed returns until their maturity date or until the investment period ends.
Conversely, shares are growth assets, with higher expected returns, but with higher risk over the short term. They are also performance based, which means returns depend upon how well the company you’ve invested in performs. For example, you might see Zip Co shares grow 7% one year, then plummet -89% the next year, depending on a number of factors including sentiment and how well the company performs.
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With fixed income, your returns are fixed. For example, for five years you receive a fixed interest rate of 3%. After year one, you get 3%, after year 2 you get 3%, and so on. At the end of the five-year period, you also get all your money back plus the interest you’ve earned on your investment.
Bonds are a common type of fixed income product. There are many different types of bonds, with two important ones being corporate and government bonds. Bonds are a vehicle for companies and governments to borrow money from investors to fund new projects or ongoing expenses. In return, the investors are paid interest on the money they have loaned.
Corporate bonds are issued by a company, for example, a bank, that wishes to raise money for business activities such as an acquisition or to build new offices.
Similarly, a government might issue a bond to raise money to build a new stadium. The government issues a bond for $1,000 which they agree to pay back in full after five years. To make the bond attractive, the government will pay an interest rate of 5% every year. That’s $50 each year – 5% of my original $1,000 investment. Once the bond reaches maturity (at the end of the investment period five years later), the investor receives the full $1,000 and the interest earned over the five-year period.
This is why bonds are a more predictable and stable investment.
3 reasons to add bonds to your portfolio
1) Reduced risk
Bonds and equities are influenced by different underlying risk factors. Bonds are influenced by interest rates, credit quality and inflation expectations. Equities are influenced by market, business, and financial risks, to name a few. By balancing these different risk factors with a carefully constructed, diversified portfolio, investors can potentially reduce the overall risk of their portfolio.
2) Predictable returns
During volatile times, bonds offer a flight to safety and a shift away from volatile markets into more conservative, stable assets. That’s why in the past two and a half years, we’ve seen a 17% increase in high net worth individuals choosing to invest for guaranteed returns according to the (ASX Investor Study).
3) A balanced, diversified investment
A term that investors might hear market pundits talk about is correlation, which means the degree to which the value of two different securities (in this case equities and bonds) move in relation to each other. While bonds and equities can exhibit positive correlation during extreme market conditions, meaning that values move in lockstep (which they did during Covid), they often have a negative correlation over the long term which is good for trying to achieve diversification.
Experienced fund managers are capable of successfully managing bond market disruption because bonds are not homogenous. Where there is drop in performance in some areas of the market, there are opportunities in others. For example, floating rate notes with investment grade credit ratings sustained a strong performance throughout covid.
Disclaimer: Nothing in this article should be construed as being personal financial advice. It is general nature only and has not taken into account your particular circumstances, objectives, financial situation or needs. An investment in the Fund is subject to investment risk. The target rate of annual return from investments retained in the Fund is not guaranteed and no assurance is given that the target rate will be achieved for any time the investment is held in the Fund. Past performance of the Fund is not a reliable indicator of future performance. No performance is forecast.
