July 26, 2019

Why you might need to rethink your fixed income strategy

It’s taken a while to gain momentum, but fixed income is starting to feature in high net worth portfolios in Australia, catching up with offshore peers.

Bonds and other fixed income instruments play almost no part in the investment portfolios of Australian high net worth individuals. This is contrary to what the rest of the world’s investors are doing. Should we be learning from our offshore counterparts?

Globally, high net worth (HNW) individual investors allocate, on average, 20 to 40 per cent of their assets to fixed income, says Jason Murray, Customer Executive, NAB Private. This sits even higher if they’re approaching retirement.

So why do Australia’s HNW individual investors typically allocate less than 10 per cent?

Murray says it largely comes down to historical reasons – to the fact that individual investors have had poor access to fixed income opportunities. “It’s a legacy of the Australian fixed income market, which has tended to be the domain of institutional ,” he says. “There’s not a well-developed bond market here for individual investors.” Unlike in the United States, Murray adds, Australia’s HNW advisers and brokers are more focused on equities than bonds. The high dividend yields of ASX50 stocks – for example, bank stocks – likely play a part here. “They have essentially been bond proxies in Australia – albeit with underlying equity risk.”

In fact, a majority of HNW investors have no exposure to bonds or fixed income at all, says Murray, and that’s because most haven’t been introduced to the asset class. “Australia’s high net worth individuals tend to invest in domestic equities, domestic property and hold Australian dollar cash. They’re under-diversified by both currency and asset class.”

As Murray notes, that’s fine if the Aussie property and equity markets are going up – and you don’t like overseas holidays. But, unfortunately, that can’t be a given.

Attitude adjustment

There are signs of change, however. One reason is that investors are becoming more familiar with fixed income as an asset class. This can be attributed to the efforts of various players in the market, including NAB, which is running its 2019 KangaNews – NAB Fixed Income Beyond Institutional Investors Conference in Sydney on 1 August for the fourth year running.

“As an investor, you don’t know what you don’t know,” Murray says. “With various education efforts and increased attention in the media around fixed income, it’s definitely starting to get a bit of momentum.”

It also doesn’t hurt that other asset classes are seeing lacklustre returns. As Greg Morris, head of NAB’s Global Investment Desk, notes, until recently there was little reason to look elsewhere when the usual suspects were paying such stellar returns. “For so many years now, investors in Australia have been spoilt because of high interest rates and high property returns. They’ve also had very high dividend yields on stocks. When you’re being paid 7.5 per cent in returns or dividends, five per cent from corporate bonds doesn’t seem as appealing.” 

So what do bonds bring to a portfolio?

In fact, there are many good reasons to invest in the fixed income market. On top of diversifying your portfolio, bonds also provide an element of stability. “In a strong economy it’s nice to see your shares jump 20 per cent,” says Murray, “but you need a stable element in your portfolio as well – for reliable income and to weather the storm in tougher markets.”

Indeed, the stable nature of fixed income makes it an obvious choice for those nearing or in retirement. “If you’re in your seventies and there’s a sudden drop in the market, you have no time to work your way out of that loss because you’re not working anymore,” Murray says. “Fixed income is ultimately more secure; it protects your principal as long as you’re prepared to hold to maturity or redemption, and you certainly have a safer portfolio.”

As Australia’s population ages, it may be that we see a rise in the number of Australians investing in bonds. However, as Morris says, it’s something investors should consider irrespective of age.

He points to the preponderance of cash investments among self-managed super funds (about 23 per cent of their assets, both in the accumulation and pension phase) and their large allocation to property, either directly or indirectly. “The education piece needs to be done with investors right through from baby boomers all the way back to millennials. Unfortunately, it probably hasn’t happened enough so far.”

Getting your fixed income fix

There are a range of fixed income instruments you can invest in. Says Murray: “Given the denomination of bonds can be high at times, one way investors can start to get exposure to fixed income is through bond funds.”

NAB Private has brought a couple to market in the past year or so, including the Gryphon Capital Income Trust, a listed investment trust (LIT), which gives investors exposure to the securitised fixed income market, and Neuberger Berman’s (NB) Global Corporate Income Trust, also an LIT, which focuses on overseas bonds. Both offer monthly distributions of income around the five per cent mark – a big step up from a term deposit in an asset class less risky than equities.

Exchange traded funds (ETFs) have also garnered interest. “There are a number of ETFs that are focused on bonds – whether that’s local bonds, hybrids or offshore,” Murray says. “That’s a fabulous way for smaller investors to get a broader exposure to the sector.”

Morris agrees. “Instead of having to put $100,000 into a single corporate bond, resulting in too much concentration in one specific company, for a fraction of the cost you can get exposure to the entirety of the market.”

He says such well diversified structures have done a great job opening up the asset class to more investors. “Innovations within the fixed income market have helped further democratise the asset class for both wholesale and retail investors.”

Tackling the risk factor

As with any investment, fixed income isn’t risk free. If you wish to divest yourself of your bonds before they mature, there’s the issue of sufficient liquidity – particularly in the rather shallow Australian corporate bond market – and a potential risk that the bonds will have lost value. An unforeseen interest rate rise, for instance, could well bring down the price of your bonds (because their fixed coupon – or fixed interest rate – is now comparatively less attractive), meaning you lose out if you want to wind things up early.

“Unlike deposits, these are mark-to-market instruments,” Murray cautions. “You don’t want to buy a five-year bond if you need the money three months later to put into a new house.”

Of course, there’s also the risk that the company will default, but, as Murray notes, “that’s not as much of a risk as with equity”.

“It’s all relative,” Morris says, which comes back to why people need to have balance in their portfolio.

As far as he’s concerned, however, the biggest risk for a portfolio right now is inertia – “the risk of clients doing absolutely nothing when interest rates are falling and inflation is eating into the value of their money”. With that in mind, those once tame five per cent returns now look quite attractive.

We’d love you to join us at the 2019 KangaNews-NAB Fixed Income Beyond Institutional Investors Conference. To find out more visit kanganews.com/events or speak to your private banker.