Why Bonds Matter

A balanced portfolio built on solid foundations can weather the economic storms.

- Alex Moffatt

As an investment, bonds are both underrated and misunderstood. They are often seen by investors as boring, defensive and predictable and producing very little in the way of income. In short, they hold little interest for income-focused investors, especially in a rising sharemarket.

However, bonds can be an important part of a well-balanced portfolio, particularly during uncertain times when sharemarkets and property markets get the jitters. If shares fall, say, 10% over a month or two – as they did towards the end of 2018 – an investment guaranteeing a 3% annual return with a guaranteed return of capital all of a sudden looks pretty attractive.

The re-election of the coalition government put a rocket under the Australian sharemarket. On the Monday after the election, the All Ordinaries Index rose 1.7% to 6565, a 12-year high.

As expected, bond prices fell, as people sold bonds to move into shares, with yields consequently rising. On that same Monday, yields on 10-year government bonds rose more than 2%, from 1.64% to 1.68%.

However, on Wednesday, May 29, the yield on 10-year bonds fell to 1.48%, which took it below the cash rate of 1.5%.

However, the threat of a slowing economy and profit warnings from several large companies means that investors and their advisers should at least consider bonds as a key part of a well-balanced portfolio. Companies to have issued profit warnings in recent weeks, or flagged worsening economic conditions, include Adelaide Brighton, Automotive Holdings Group, Scentre, CSR, Reliance Worldwide, Boral, Qantas, Domain, Flight Centre and Virgin Australia.