Despite the resurgence of equities over the past 12 months and the consequent return to double digit returns by most Australian super funds, fixed interest should remain a key part of a well-diversified portfolio.
That is the assessment of the fixed interest experts as they assess the outlook for 2005 and conclude that while it remains positive, conditions will not be as bullish as experienced in 2004.
According to the head of fixed interest at Perennial Investment Partners Glenn Feben, recent experience, not least the negative returns experienced between 2001 and 2003, mean fixed interest will remain fundamental to most asset allocation strategies.
“Fixed interest plays a key role in any diversified portfolio,” he says. “And I believe that this is well understood in the wholesale funds industry.”
Feben stresses that fixed interest allocations are generally not focused on returns but are instead attractive for the low correlation that they hold to other asset classes. The principal role of a fixed interest investment, Feben says, is risk management.
“Fixed interest assets are those that do well when things turn nasty.
“Fixed interest assets truly show their value when there is an economic downturn and interest rates fall,” says Feben.
However, Feben’s views are not necessarily shared by all within the investment industry. According to Ross Gustafson, head of fixed interest at Tyndall Investment Management, it is becoming increasingly apparent that investors can do better in other asset classes where they can take on more risk.
“It is our prediction, that in 2005, returns on equities will outperform returns on bonds,” he says. “It is even possible that property will outperform bonds… though the good run that property has enjoyed must inevitably change.”
Feben discourages such a view.
“There is a growing trend for some investors to place more risk in their defensive assets. What they may not realise is that this increases the correlation between their defensive assets and their growth assets, thereby leaving little overall portfolio protection,” he says.
Ross Gustafson is not alone in his assessment. The managing director of Frontier Investment Consulting, Fiona Trafford Walker also believes that fixed interest assets are losing their appeal.
Trafford Walker believes cash will be favoured over bonds when the investment options of many superannuation funds are examined.
Gustafson believes that the bond sector in Australia is just not what it used to be.
“There has been a corporatisation of the bond sector,” says Gustafson. “And the Government moving from deficit to surplus has had a recognisable effect.”
Gustafson suggests that it is even possible that the Government will look at removing all of its bonds in the near future, particularly if the full sale of Telstra comes to fruition.
“With superannuation demand expanding, the market has moved into the corporate sector,” he says. “Fifty per cent of the bond sector now resides in corporate debt. As a result, there is a high crossover between the bond market and the Australian stock exchange.
“What this means is that fixed interest assets are more risky than they used to be. That risk comes from corporate default. The fixed interest bond market is now acting more like the equities market,” says Gustafson.
Feben, while not disagreeing with Gustafson’s assessment with regard to the corporatisation of the Australian bonds market, stresses the integral role that fixed interest assets play for most portfolios, particularly with a longer-term of maturity.
“It is all linked to economic health. A longer duration of fixed interest investment will always give a greater measure of protection,” he says.
Gustafson and Trafford Walker see much greater value in short-term fixed interest investments.
“Business cycles have become far more dampened in recent years. Bank activity has become more preemptive than reactionary. As a result, the popularity of short maturity bonds that are less sensitive to interest rate changes has increased,” Gustafson says.
Trafford Walker agrees with this assessment.
“In terms of the maturity of a fixed interest investment, long-term risk simply isn’t paying off. At the moment, a long-term allocation is locking in a return that could be obtained from a shorter-term investment,” she says.
Feben believes that while the returns granted by fixed interest investments may not always be exceptional, their value cannot be underestimated.
“In 2004, fixed interest returned as little as 2-3 per cent but this was not a problem because the 60-70 per cent of portfolio assets that were located elsewhere generally returned nicely,” he says.
Neither Gustafson or Trafford Walker believe fixed interest assets will ever disappear from a properly diversified portfolio, though both see it as an asset class whose attractiveness is declining.
Trafford Walker’s concession sums up the current investment landscape well.
“A diversified portfolio should always contain some bonds, however, the reality at the moment is that there is greater income to be obtained from other asset classes.”
