Global government bonds and global credit have become overvalued with yields falling by over 0.5 per cent, and now could be a good time for medium-term institutional investors to increase their allocation to growth assets, according to Mercer.
Australian bonds remain fair value but there was a surge in high quality global government bonds in the third quarter of 2010, according to Mercer’s Quarterly Market Valuation and Review.
“The yields are now lower than the level reached at the end of 2008, and it is real rates, rather than inflation expectations, that have fallen the most,” said David Stuart, head of Mercer’s Dynamic Asset Allocation team in Australia and New Zealand.
Mercer has previously recommended global government bonds to provide insurance against adverse economic outcomes but Stuart said the cost of this insurance is now becoming prohibitive.
“Global corporate bond yields are now at levels last seen in 2003, and are beginning to look a little expensive. Nonetheless, compared to government bonds, they still have a relatively attractive spread,” he said.
Both overseas and Australian shares were rated as ‘fair value’ as many major markets rallied in the third quarter, returning 10 to 15 per cent.
“It is true the outlook for developed economies remains uncertain, yet serious talk of a double-dip recession has waned, and the consensus for 2011 global growth remains above 3 per cent,” Stuart said.
Positive valuation signals from global equities with the wide gap between equity and bond yields are offset by macroeconomic risks, but with the poor performance of defensive assets Mercer recommended going overweight in equities and other growth assets, Stuart said.
The Australian dollar was rated as unattractive relative to the US dollar but neutral versus the euro and the Japanese Yen.
“Overall, we believe the Australia dollar is overvalued against the US dollar, and that eventually we will move closer to long term equilibrium levels. Our advice is to take advantage of current rates to buy unhedged overseas assets,” Stuart said.
