The game is bonds, fixed-interest bonds

Which investment class returned more than 11 per cent last year? You would be right in assuming it wasn't shares. But odds are that most investors would have missed the fact that it was bonds.

Which investment class returned more than 11 per cent last year? You would be right in assuming it wasn't shares. But odds are that most investors would have missed the fact that it was bonds.

Yes, bonds. Those boring debt securities that most investors tend to shun in favour of things they can more easily understand, such as cash and term deposits.

While we were all congratulating ourselves on locking in term deposits at 7 per cent or 8 per cent, the smart money was earning double-digit returns in the bond market. And if bondholders needed their money back, there were no penalty fees or break costs to worry about.

But chances are your financial adviser was as much in the dark about the opportunities in the bond market as you.

The truth is that it is not just ordinary investors who are ignorant about fixed-interest investments.

Many financial advisers prefer to concentrate on the share component of their clients' portfolios at the expense of more defensive investments. Unfortunately, this means investors might not be getting expert advice on the full range of opportunities available.

Bond manager Pimco surveyed 204 financial advisers in mid-December to find out their attitudes to bonds and term deposits.

The research, by Marketing Pulse, found a continuing lack of understanding of bonds and the opportunities they presented.

Not one of the advisers surveyed, for example, thought their clients had earned more than 10 per cent on their fixed-interest investments last year. The bulk thought average returns had been about 6 per cent or 7 per cent. This is despite global and local bond and credit indexes all in double digits.

Expectations were much the same for the coming year, with just 5 per cent of advisers predicting returns of 8 per cent or more.

To be fair, none of us knows what markets will do this year. And both 2010 and 2011 were bumper years for bonds with bond values buoyed by falling global interest rates. The returns were unusual and there are plenty of arguments why it is time for bond markets to take a breather.

But the head of global wealth management for Australia at PIMCO, Peter Dorrian, believes that fixed interest, at best, is given only begrudging acceptance in Australian portfolios.

There is little doubt that, compared with other developed countries, Australia has a love affair with shares. Our super portfolios are heavily weighted towards "growth" investments such as equities whereas in Europe, in particular, retirement savings tend to be predominantly in bonds.

When we want to park our money somewhere safe, we're more inclined to put it in something that's easily understood and accessible, such as a term deposit or high-interest savings account. Or even in the comparatively more risky "hybrid" market, in which debt securities issued by big-name companies have been selling like hot cakes to retail investors on the basis of a familiar name and an attractive yield.

Fixed interest, by comparison,

is complex.

Bond prices fluctuate just as much as share prices but are much less transparent to retail investors. You generally need a big swag of money to buy an individual bond and to get a truly diversified portfolio you need to consider questions such as duration (how long the bonds have before they mature), credit quality (how likely the lender is to repay) and liquidity as well as the yield.

Term deposits are so much easier.

However, Pimco's research shows only a minority of advisers think their post-retirement clients understand the liquidity costs of term deposits. That is, how much you lose if you need your money back early.

With most term deposits taken out for less than two years, Dorrian says investors might also face unexpected rollover costs when their term deposits mature. It is highly unlikely new term deposits will be available at anything approaching existing levels. These shorter-duration term deposits are arguably more like cash than what the boffins call fixed interest.

While cash and term deposits serve a need, investments such as bonds can offer liquidity, a broader exposure to the fixed-interest market and the opportunity to profit when interest rates fall. (Falling interest rates increase the value of existing bonds, although rising interest rates reduce their value.)

And while many pundits are warning investors against plunging into bonds on the basis of past returns (always good advice), Dorrian says the US and European central banks have made it clear they won't be lifting rates until at least 2014. He says the running yield on international bonds is also about 8 per cent, which provides a decent buffer against any capital losses.

Retail interest in fixed interest is also expected to be sparked by the listing of existing bond funds and new fixed-interest exchange-traded funds on the Australian Stock Exchange later this year. This means investors will be able to buy and sell fixed-interest products much in the same way as they do shares, which is particularly appealing for the self-managed super fund market.

Bond managers and ETF issuers are already salivating at the prospect of this potential new market.

But investor ignorance and a product sales pitch can be a dangerous combination.

Easier access to fixed interest is desperately needed. But for investors to get real benefits, transparency and education will be critical. That is something the issuers, and advisers, need to start work on now.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles