By Leon De Wet
Covid-19 hasn’t just delayed the premier of James Bond’s “No Time To Die”. It’s also brought Government Bonds back into consideration.
In diversified portfolios, investors have traditionally used government bonds mainly to:
i) deliver income; and
ii) provide capital protection against a downturn in equity markets due to falling yields.
We have certainly seen a downturn in equity markets this month. But does that mean that government bonds are an automatic choice?
Starting bond yields are an important factor to consider. Higher yielding bonds provide a greater level of income and vice-versa. Also, given the inverse relationship between yield and the price of a bond, the higher the yield the greater the possible capital gains as yields have further to fall, helping to offset any losses on equities.
Government bond yields are now at historic lows. At the time of writing, the yield to maturity on the Bloomberg AusBond Treasury 0+Yr Index is 0.7%. This means they presently offer very little income. In fact, real returns after the impact of inflation are actually negative. At the same time, the scope to deliver capital gains is substantially less than it has been in the past.
Investors should be cautious about blindly relying on conventional assumptions around the defensiveness of government bonds, and not forget about the inverse relationship between yield and price. These investments are at the heart of the asset bubbles created by unconventional central bank actions that have driven yields to historic lows. Going forward, they are unlikely to offer the same risk/return characteristics they did a decade or more ago.
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