Wednesday 16 November 2022 by Jonathan Sheridan Opinion

Bonds offer best returns in a decade

The following piece was originally published as a sponsored article in The Australian and is something we wanted to share with you to showcase the excellent value available in corporate bonds.

After a decade of declining yields, bonds are now offering attractive returns.

With ongoing market uncertainty and persistent volatility, investors are turning to safer asset classes such as fixed income, in particular corporate bonds.

Generally, bonds offer a safer investment option that provides investors with a stable, predictable income and capital preservation – i.e., protecting the value of assets, particularly in a more volatile environment.

Unlike equities, bonds have fixed cash flows and the reasonable expectation of receiving back the face value of an investment at maturity. With recent rate movements, investment-grade bonds are returning up to 7%p.a., offering attractive value.

What might seem counterintuitive for investors with an equity background is that periods of market volatility are great opportunities in the bond market to lock in those attractive rates.

In this context, we see great value in some of the higher-quality names, such as the investment grade Challenger Life, which came to market with a 7.186% semi-annual coupon, callable in 2027. We also recently saw investors flock to the recent AMP new issue, offering a high yield exposure in the form of a floating rate note paying an attractive coupon of around 7.50%, providing a high-income stream.

Demand from new investors to the asset class is also reaching levels not seen for nearly a decade, as the yields available now, in many cases, are greater than the fully franked dividends offered by the equities of listed issuers.

The chart below illustrates the higher yield on offer from bonds now compared to prior years, with the generic BBB rated 5-year corporate bond yield creeping above 6.00%, which hasn’t been reached since 2012. These are investment grade rated bonds, proving in the current environment, there is no need to sacrifice quality to achieve yield. In fact, with ongoing market uncertainty and volatility, we believe it’s these better-quality exposures that will provide a defensive allocation in portfolios.

New client enquiry is up nearly seven to nine times the levels of the past few years when interest rates were at or close to zero.

SMSF trustees continue to prefer cash to bonds, as they did even when cash was yielding almost nothing, as shown by the latest stats from the ATO, where the allocation to bonds has remained steady at around 1.5%. Cash allocations declined from the mid-20% to the low 20% area as rates approached zero.

Given investment grade bonds, with a near-perfect repayment history over the last 30 years or so, typically pay a premium of 1% to 2% per annum over a term deposit, it would seem likely that allocating this cash to these bonds would make sense given the yields now on offer and the low incremental risk taken versus a deposit.