Aussies hoping bonds will pay equity-like returns

Investors are continuing to invest in bonds, putting aside the massive losses on bonds generated as interest rates rose quickly and betting that we are either at or near the peak for interest rates.

Research from Calastone showed that Australian bond and fixed-income managed funds pulled in $2 billion in net fund inflows over the most recent quarter, as equity funds suffered very weak inflows.

One of the reasons for this investment revolution is that Australian government bond yields are now matching the nominal yield from ASX 200 dividends.

That does not happen very often and when it does, it can produce equity like returns from bonds with a much lower risk of capital loss.

Bonds remain volatile but in demand

While the bond market has remained volatile due to speculation about the direction of official interest rates and the war in the Middle East, the rush to bonds is happening around the world and not just in Australia.

Two bond exchange traded funds in the US from Vanguard and BlackRock have both exceeded or drawn close to the magic US$100 billion mark for the first time, showing the extent of the rush into bonds despite some massive capital losses for bond funds over the past couple of years.

It has been a similar scene back here in Australia with, $2.6 billion flowing into fixed income ETFs in the September year as ETF providers including Betashares, Global X and iShares launched new products.

VanEck alone launched three Australian government bond ETFs in September and Morningstar numbers show that in the first half of this year, investors in the United States poured US$99.4 billion (A$144.3 billion) into fixed income ETFs.

European demand for fixed income ETFs also hit record levels as investors added US$36 billion (A$52.2 billion) into listed bond funds.

Vanguard confirms the rush on bond ETF’s

Vanguard numbers show that collective investment inflows into Australian and global fixed income ETF products totalled $2.49 billion over the first half, far ahead of inflows of $1.56 billion into Australian and global equity ETF products.

Fixed income ETFs that invest in government bond funds with high investment grade credit ratings have been the biggest beneficiaries of the investment activity.

Australian fixed income ETFs took just under 70% of total fixed income inflows in the first half, with products that invest across domestic bonds and other fixed income securities attracting $1.73 billion of cash inflows.

That represents a 65% increase over the Australian fixed income inflows recorded in the first half of 2022.

Meanwhile, global bond ETFs received $763 million over the first half, representing a 32% increase over the first half of 2022.

Making money from higher interest rates

“Although rising interest rates have created short-term pain for Australian investors, they have helped to improve long-term return expectations for bonds,” said Duncan Burns, Vanguard’s Head of Investments, Asia Pacific.

“While bond prices typically reprice lower when interest rates rise, investors with a sufficient long-term investment horizon will ultimately be better off.

“Investors are also flocking to bonds in their search for diversification and income as yields continue to stabilise (a signal that investors are becoming more optimistic), presenting an attractive alternative to holding cash which has generally underperformed bonds post rate hike cycles.”

The Australian ETF market continued to grow over the first half, with assets under management reaching a record $146 billion at the end of June, up from $143.5 billion at the end of May.

“The inherent diversification benefits of ETFs – where one trade can provide investors with exposure to not only hundreds of securities, but also to different markets and asset classes – reduces the need for investors to pick and choose winning stocks, and the costs that goes with buying individual securities,” said Mr Burns.