Maintaining a diversified bond portfolio for the remainder of 2024 may be prudent due to increased macroeconomic uncertainty and geopolitical risks that continue to play out.

Bond markets suffered a weaker start to the year than expected, due to stubborn inflation, posting losses and underperforming relative to global equities. 

In the four months to April 30, global bonds hedged to the Australian dollar lost 2.01% and Australian bonds declined by 0.98% in the same period.¹

“Government bonds in Australia have underperformed relative to credit, as sticky inflation and interest rate outlook repricing has weighed on sentiment. By comparison, the relative strength and resilience in corporate earnings, has helped the domestic credit market year-to-date,” said Andrew Zenonos, Portfolio Manager at Russell Investments.

Fixed income exchange traded funds (ETFs) continue to attract capital, ranking second behind only global equities in a Betashares analysis of industry inflows during March. The overall sector garnered inflows of $453.4 million during the month, with Australian bond ETFs capturing $338.2 million of that amount.

AUSIEX adviser trading data has shown the net traded value (buy value less sell value) of Australian Dollar fixed income ETFs has more than doubled from January to April 2024, whilst inflows into global fixed income ETFs have also increased steadily from January.

Australian dollar fixed income ETFs listed on the ASX include the iShares Core Composite Bond ETF (ASX: IAF), Betashares Australian Bank Senior Floating Rate Bond ETF (ASX: QPON), Vanguard’s Australian Fixed Interest Index ETF (ASX: VAF) and Russell Investments Australian Select Corporate Bond ETF (ASX: RCB).

Global fixed income ETFs on offer include the Vanguard Global Aggregate Bond Index (Hedged) ETF (ASX: VBND), Global X US Treasury Bond ETF (ASX: USTB) and Betashares Sustainability Leaders Diversified Bond ETF – Currency Hedged (ASX: GBND).

CBOE also gives advisers access to an additional five listed domestic fixed income funds and four international fixed income funds.

Market outlook

Emma Lawson, a Fixed Interest Strategist – Macroeconomics at Janus Henderson, says near-term market pricing hinting at a rate hike in 2024 and limited cuts in 2025 underestimates the risks to the economy after a long period of policy tightness.

“We currently consider the Australian yield curve as under-valued at points in the curve. We hold a long duration position and look to add to it on any worsening of the economic outlook,” Lawson said.

“In recognition of the complex macroeconomic and geopolitical environment, our credit strategy remains skewed towards high-quality, investment grade issuers with resilient business models, solid earnings power and conservative balance sheets.

“While acknowledging that credit spreads in general have tightened considerably, all-in yields particularly in low/no default-risk investment grade credit remain highly attractive. We have been actively and selectively taking advantage of these yields in highly-rated corporate bonds and structured credit, particularly in the primary markets where transactions have come with new issue concessions,” Lawson explained.

The all-in return of a bond is the sum of its base rate plus the credit spread. Recent primary issues include Perth Airport’s A$300 million seven-year bond, which was seven times oversubscribed, and a Macquarie Bank BBB rated Tier 2 bond with an issue yield of 5.95%.

Russell Investments’ Zenonos also expressed optimism about the potential for bond markets to perform relatively well for the remainder of 2024, arguing they “present an attractive opportunity for investors”.

“We are nearing the upper end of where yields will sit. We expect that as the year rolls on yields will start to fall, which provides capital appreciation for investors,” he said.

“Increased uncertainty at the macroeconomic level, as well as geopolitical risk, mean that maintaining a diversified portfolio and sticking to disciplined investment processes will be key to ensuring portfolios meet their objectives.”

If inflation was to remain above the Reserve Bank of Australia’s expected range for a prolonged period, and the bias moved to interest rate hikes, it is likely that government bonds would continue to come under pressure.  If rate cuts were delayed shorter dated government bonds would likely underperform longer-dated government bonds.

¹ Bloomberg Global Aggregate Total Return Index Value Hedged AUD, Bloomberg AusBond Composite 0+ Yr Index.