Bonds may be boring, but you pay for safety

TUNE into a typical pub conversation and you’ll likely pick up a share tip, along with an appraisal of the umpire’s weekend performance. But unless it’s a hostelry frequented by high-finance types, you’ll never eavesdrop about the hottest returns in the bond market.

Relative to equities, debt markets (that is – bonds) are poorly understood here and that’s especially the case with corporate bonds.

“Australia doesn’t really have a culture of fixed income [bond] investing,” says Betashares chief economist David Bassanese. “This applies not just to retail investors, but to our largest super funds which have significantly lower fixed interest allocations relative to their global pension fund peers.”

In the first half of the year, avoiding bonds wasn’t such a bad idea because they have tumbled in value on the back of rising interest rates (the market value of a bond and interest rates move in opposite directions).

Rates have been rising on the back of deliberate central bank action to cool down overheated economies and – thus – inflation. But they can only go so far or else they will induce a recession and the great guessing game is what this tipping point is.

Arguably, long-dated bond valuations already factor in the further rate rises required to tame inflation – and more. If that’s the case, bonds make for a compelling investment at beaten-down valuations.

We hasten to add there’s a lot of ‘whys’ and ‘wherefores’ and prices can move violently on the single action – or even utterance - of a central banker.

Look no further than the dramatic reaction to last week’s 25 basis point official cash rate increase from the Reserve Bank, which was half what punters expected and construed as the magic signal that inflation was starting to abate. The local share market surged, while the Australian 10-year bond rate – a signal of where investors expect rates to settle in the longer term - also fell from over 4 per cent to 3.72 per cent.

The 10-year rate has since spiked again, to close to its eight-and-a-half year peak of 4.05 per cent attained in June. So, has inflation really been conquered? Yeah, nah.

In the case of corporate bonds, investors are enjoying a double whammy. That’s because the base interest rate (referenced off treasury yields) has increased, but so too has the spread (the extra margin the holder receives for accepting risk beyond supersafe government paper).

As with all bonds, investors will recoup the face value of the paper at maturity – unless the issuer defaults.

Examples of returns include Qantas paper maturing in November 2029 (current yield to maturity 5.5 per cent), Downer (April 2026, 5.1 per cent) and Chadstone half owner Vicinity Centres (April 2027, 4.8 per cent).

ASX-listed exchange traded bonds (XTBs) offer a direct exposure to bonds issued by some of Australia’s biggest listed companies, including Qantas, Telstra and Origin Energy. The XTBs are tradeable in the same way as shares.

This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.