Attention Turns to Fixed Rate Bonds

Longer-term fixed rate bonds have not been an attractive investment for some years. The interest rate on these bonds was extremely low and there was the risk of capital returns if rates rose. However, interest rates have now reset higher which makes government bonds a much more attractive proposition.

Tim Rocks, Chief Investment Officer at E&P Research, says that in the aftermath of COVID, the interest rate on 10-year Australian government bonds fell to a paltry 0.6 per cent.

“At that level, bonds were particularly unattractive because the rate itself was low and the risk of potential capital losses were large. However, as interest rates have now moved substantially, fixed rate bonds are now far more appealing. The same 10-year Australian government bond yields are now earning more than 4 per cent* and there is as much risk of capital gains than losses,” he says.

The potential for portfolios

Rocks explains that rates on almost all interest rate securities including term deposit rates and corporate bonds have increased in recent months ― but the rise in government bond yields is particularly striking. So, with yields for government bonds now well in excess of prevailing term deposit rates, there is a greater investment case.

He outlines factors investors should consider for switching a portion of their interest rate security holdings into government bonds.

• Interest rates: on bonds are now attractive at more than 4 per cent and the increase has been greater relative to other instruments.

• Diversification benefits: buying some government bonds can be an effective way to add diversification to investor portfolios.

• Credit risk: is set to rise as the economy slows, which could potentially impact returns on credit portfolios. Government bonds have limited credit risk.

• Capital gain potential: if interest rates fall from current levels there is the potential for capital gain. And if economic conditions worsen, it is possible bond values would rise, which historically coincides with a fall in equity prices.

“As a result, the scene is now set for traditional fixed income options such as Australian government bonds to become more appealing – so, investors should speak to their adviser about whether this is appropriate for their portfolio,” he says.