Tuesday 25 November 2014 by Elizabeth Moran Education (basics)

Busting the seven key myths about bonds - Part 4

Over the last 15 years, the FIIG team has had thousands of conversations with investors who are considering investing in bonds and other fixed income investments.

We’ve come to recognise some key concerns that investors quote when discussing a potential investment, most of which are based on false assumptions. So, if you’re still unsure about bonds, this series of articles which delves into the “Seven Key Myths” may help.

Myth #4 Fixed Income returns are low and will be a drag on my portfolio’s performance

Reality #4 Fixed income returns over the 21 years since May 1993 have been 7.73%, while shares have returned 10.08%, a difference of just 2.35% not what you would expect for much lower risk bonds.

Bonds range from being very low risk to high risk and there are other fixed income options such as deposits and hybrids to suit all investors. While returns are generally lower than shares, the securities are in most cases lower risk. They sit higher in the capital structure so that in the event of default they are repaid before shares and other lower ranking creditors. The exceptions being the new style bank subordinated bonds and hybrids which convert to shares under certain conditions.

The graph below compares the ASX 200 Accumulation Index to the Bloomberg AusBond Composite Index from 29 May 1992 until 23 October 2014. The graph has been rebased to September 1989 when UBS initially commenced the index. In September 1989, $1,000 was invested in both indices and interest or dividends added back to show returns. However there is no allowance for franking credits.

The light blue line is the Bloomberg AusBond Composite Index made up of about 70% very low risk government bonds and the rest are investment grade corporate bonds. It’s a steady upward sloping line with only a few small highs and lows. The dark blue line, which represents the ASX 200 Accumulation Index, is more volatile and shows much higher peaks and deeper troughs. Over the 21 years since 1993 the ASX Accumulation Index returned 10.08%, while the Bloomberg AusBond Composite Index returned 7.73%, a difference of just 2.35%, not what you would expect for much lower risk bonds.

In stressed markets, the bonds outperformed and had you held them in your portfolio, they would have helped smooth overall returns.

While you would expect lower returns for lower risk, investing in fixed income doesn’t mean it will be a drag on your portfolio’s performance.

Those investors that are prepared to trade their bonds would expect higher returns than the Composite Index.

S&P Accumulation index v Bloomberg AusBond Composite Index