Best supporting performance: why bonds should have a starring role in your portfolio

And the award for the best-performing asset class for the 10-year period ending June 2017 goes to (wait for the drum roll)…

GLOBAL BONDS!

A shock result perhaps, but this is no envelope malfunction à la La La Land.

According to Auckland-based consulting firm Melville Jessup Weaver (MJW), offshore bonds were the place to be for NZ investors from the onset of the global financial crisis (GFC) in September 2008 until almost exactly a decade later.

The MJW September 2017 quarter NZ investment survey, which plotted the performance of the five main asset classes used by local investors – cash, NZ bonds, NZ shares, international shares, and global bonds – shows the latter well in front until about June this year.

“Bonds, benefitting from a continued downward trend in interest rates, have also performed strongly,” the MJW study says. “It is interesting that up until mid-2017 global bonds would have been the best choice out of the asset classes shown for this period.”

(As an aside, NZ bonds held their own with their offshore cousins until about mid-2013 before steadily dropping away over the following four years.)

MJW measured the performance simply on the relevant asset class indices rather than real fund manager returns. In the global bond category, for example, MJW figures show the best-performing manager over the 10 years to September 30, PIMCO (the underlying manager for the Hunter Global Fixed Income Fund available on InvestNow), returned an annual 9.4 per cent compared to the benchmark 7.3 per cent.  Russell Investments,  also available on InvestNow, show a return of 8.7% for this same 10 year period in the MJW survey.

Hindsight in funds management, of course, is a wonderful thing (InvestNow plans to launch its suite of products yesterday) but very few investors would’ve been fully-invested in global bonds for the period in question.

And nor should they have been. The award-winning 10-year performance of global bonds may have been a nice bonus but professional investors don’t typically allocate to fixed income assets expecting such outsize returns.

Historically, bonds (also called “fixed interest”) – both global and NZ – have returned less than the other main asset class, shares, over longer periods. Furthermore, common sence suggests that this relationship will persist in the future, as higher risk shares should outperform bonds in the long term.  However, it is key to remember that the fixed income asset class – comprising the many thousands of bonds, or debt securities, issued by governments and companies around the world – has a dual-purpose function in portfolios:

  • to provide regular, secure income above cash returns with the prospect of some capital gain; and,
  • to protect investors against sudden losses in their equity holdings.

The second – possibly most important – role of fixed income illustrates the power of diversification in portfolios. If share markets fall sharply, bonds typically rise in value, helping put a floor on overall portfolio losses.

While the relationship of equities and bonds is a complex one that changes over time, the core diversification quality of fixed income remains a compelling reason to consider the asset class even as its show-stopping period may have come to an end for now.  Looking forward, while many forecasters think the returns from fixed interest will be a lot more subdues in future, this is an asset class that still plays an important role within a diversified portfolio.

How much investors wish to allocate to fixed income will depend on their own risk tolerance, usually a function of age, goals and personality. There are plenty of online tools now available to guide investors through this process (including the Sorted website linked via InvestNow) or a financial adviser can help out.

In some ways, though, investing in fixed income is often more complex, and challenging, than buying shares, which is why just about all investors use specialist managers to access the asset class, especially globally.

For one, a large proportion of bonds are only available to institutional investors.

Furthermore, fixed income typically requires greater diversification of underlying securities than equities: to illustrate, if one bond defaults in a portfolio of ten fixed income securities then a 10 per cent loss is locked in with no hope of recovery; conversely, if one stock fails in a ten-share portfolio, gains in any of the other nine may make up or exceed the loss.

NZ fixed income investors also need to think beyond their own borders.  The Bloomberg Barclays Global Aggregate Index, which is often used as a benchmark by global fixed interest funds, is comprised of approximately 15,000 securities, which also includes a wide range of investment opportunities that simply aren’t available in NZ.

However, an analysis I carried out a couple of years ago suggested most retail investor portfolios had little exposure to offshore bonds. According to my research, KiwiSaver schemes and company super funds accounted for just about all of NZ’s allocation to global fixed income funds.

Admittedly, those funds invest on behalf of individual Kiwis, but that doesn’t mean investors should ignore fixed income in their portfolios held outside those locked-in retirement savings vehicles.

To cater to that need, InvestNow has several fixed income options (domestic and global) on its cast in addition to Hunter and Russell Investments, with fixed interest funds also from AMP Capital, Fisher Funds, Harbour, and Nikko now showing at a platform near you.

By |2019-01-17T11:41:03+00:00November 28th, 2017|Uncategorised|0 Comments