Bonds

Hi Peirto,

Thanks for the kind words. We think your reasoning is broadly sound.

The old rule that bond exposure should automatically rise with age is too simplistic. Income needs, investment timeframe, tolerance for volatility and the ability to withstand an equity downturn are more important than age alone.

We currently see value in fixed-rate bonds, believing markets are pricing an overly hawkish outlook for the RBA and Federal Reserve. If rates remain on hold or ultimately decline, bond prices should benefit. Yields in the mid-6% range on subordinated debt issued by the major banks also look appealing, although this carries more risk than senior or government bonds.

You raise an important distinction between ETFs and direct bonds. We generally prefer direct bonds in the wholesale portfolios we manage, but minimum investment sizes, diversification and transaction costs can make them less practical for smaller portfolios.

When an individual bond is bought and held to maturity, its yield to maturity can broadly be locked in, assuming the issuer does not default. A conventional bond ETF is different: it continually replaces bonds as they mature, so its income and portfolio yield change over time. Consequently, an ETF’s current distribution yield is not locked in indefinitely.

That said, bond ETFs provide simple, diversified access to fixed income. We own the iShares Core Composite Bond ETF (ASX: IAF), which holds a broad portfolio of Australian government, semi-government and investment-grade corporate bonds.

The appeal is twofold. IAF currently offers a portfolio yield of around 4.8%, providing attractive income by recent historical standards. It should also benefit if inflation moderates and interest rates decline, as falling market yields generally lift bond prices. However, the reverse is also true if rates rise further.

Overall, we think there is a reasonable case for adding fixed income at current yields, particularly for portfolios heavily weighted towards equities. Short-dated, high-quality bonds provide greater stability, while longer-duration bonds and broad ETFs such as IAF offer more potential capital upside if the interest-rate cycle turns.