High quality bonds are in the spotlight as recent developments in global financial markets have highlighted persistent challenges in the international investment landscape. Current factors creating market uncertainty include:

• Heightened geopolitical tensions across multiple regions impacting global trade flows.
• Central bank monetary policy adjustments in response to inflation pressures
• Supply chain disruptions affecting various industries and commodity markets.
• Economic growth concerns across major economies creating earnings uncertainty.

Global Markets Reaction

As we have witnessed, markets typically react adversely to uncertainty which can result in significant losses in equity markets amid heightened volatility. Factors such as leverage, lack of liquidity and the dash for cash can lead to severe movements in asset prices during these times.

In commodity markets, substantial price fluctuations often occur during volatile periods, with energy and industrial metals particularly vulnerable to variation. Fixed income markets have been modestly affected, mostly in the corporate bond and hybrid space, with a widening of credit spreads pushing down capital prices approximately 1-1.5% for investment grade rated instruments. Sub-investment grade bonds fared worse, with wider credit spread widening pushing down capital prices by approximately 3.5%. Government bond yields (and capital prices) have remained relatively stable.

The following table represents the price change percentage (%) in key asset classes for the period 26 March – 9 April 2025.

Most notably, during periods of high volatility, fixed income assets (i.e., government bonds and high-quality corporate bonds) experience smaller price changes when compared to equity and commodity markets. This pattern has been consistent across multiple historical market correction events, including the 2008 financial crisis, the 2020 COVID market crash, and other significant downturns.

The Mechanics Behind Bond Price Stability

When market uncertainty arises, investors typically seek safer assets—a phenomenon known as “flight to quality.” This increased demand for government bonds tends to push their prices up and yields down. Additionally, during economic uncertainty, inflation expectations and growth forecasts often decline, further supporting bond prices. This counter-cyclical behaviour is what makes bonds valuable portfolio stabilisers.

Diversification: The Foundation of Risk Management

Diversification is a key investment strategy designed to reduce risk and improve the stability of returns by spreading investments across different asset classes, sectors, regions, and financial instruments. The objective is to create a smoother total return for an investment portfolio. By holding a variety of investments that are not closely correlated, an investor can reduce the overall volatility of their portfolio and protect against significant losses in a single area.

Benefits of Diversification:

• Lower portfolio risk – if one sector or asset class underperforms, gains from other areas can offset losses elsewhere.
• More stable returns – diversified portfolios generally deliver more consistent returns.
• Protection against market volatility – helps buffer against market downturns.
• Benefits of adding bonds to an investment portfolio can include:
  • Income generation – bonds provide regular, predictable income by way of coupon payments paid by the issuer to the investor. For investors seeking reliable cash flow, bonds provide a stable source of income compared to other assets that may have variable dividend payments.
  • Capital preservation – bonds, particularly government and highly rated corporate bonds, are seen as safer investments because they return the investment principal at maturity (assuming no default). This makes bonds suitable for risk-averse investors or those seeking to preserve capital.
  • Portfolio diversification – bonds typically have a low or sometimes negative correlation with asset classes such as equities. When equity markets decline, bonds often increase in value, thereby offsetting portfolio losses.

Bond Risks and Considerations

While bonds offer significant portfolio benefits, investors should also understand their potential drawbacks such as:

• Interest rate risk – when interest rates rise, bond prices typically fall. Longer-duration bonds are more sensitive to interest rate changes.
• Inflation risk – bonds with fixed coupon payments can lose purchasing power during periods of high inflation.
• Credit risk – the possibility that issuers may default on interest or principal payments. This is particularly relevant for lower-rated corporate bonds.

Types of Bonds

• Fixed rate bonds – an instrument that pays a fixed rate of interest, known as the coupon rate, to the bondholder for the entire life of the bond, in addition to repaying the principal (bond face value) at maturity. Coupons are typically semi-annual. These bonds are popular for investors seeking predictable and stable income.
• Floating rate notes – an instrument that pays a fixed margin over a floating interest rate benchmark, such as the 90-day bank bill rate. Coupon payments are reset usually each quarter against the underlying benchmark rate – if 90-day bank bill rates decline, coupons paid will be lower; conversely, if 90-day bank bill rates increase, coupons paid will increase.
• Inflation-linked bonds – bonds whose principal value adjusts with inflation, providing protection against purchasing power erosion.
• High-yield bonds – bonds issued by companies with lower credit ratings that offer higher yields to compensate for increased credit risk.

Implementation Strategies

Investors can access bonds through several vehicles including:

• Individual bonds – direct purchase of specific issues.
• Bond mutual funds – professionally managed portfolios offering diversification.
• Exchange-traded funds (ETFs) – bond portfolios trading on exchanges.
• Bond ladders – staggered maturities to manage interest rate risk.

Key takeaways

Bonds provide a combination of stability, predictable income, and diversification. As part of an investment portfolio, bonds can play an important part in balancing risk and return. The appropriate allocation to bonds depends on factors such as investor risk tolerance, investment time horizon, income needs, and overall financial objectives.

NAB’s Global Bond Service provides wholesale investors with direct access to bonds with highly rated issuers including Federal government, State government and corporations (including banks and insurers).

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

The information contained in this article is believed to be reliable as at April 2025 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information or acquiring any product or service, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

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