The 30- year Easy Road For Bond Investors Just Reached A Dead-End

market analysis

Peak performance is also about coming down the mountain well.

By

Paul Ashworth, Managing Partner


Posted 21 September 20

Peak performance is also about coming down the mountain well.

Interview with ausbiz, 21 September 2020

In an interview with ausbiz, an independent business and investment news platform, Paul Ashworth highlights three segments showing signs of reasonable risk-adjusted returns.

Watch the recorded session here.

Paul Ashworth from Cameron Harrison says that the easy road/easy returns for local bond holders and fixed interest over the last thirty years is finally over. There are reasonable risk-adjusted returns elsewhere which investors ought to consider as part of a carefully constructed, well diversified asset allocation structure.

The last 30 years in Australia and globally has seen declining bond rates which have generated correlated (super) returns to bond markets, equity markets and property. With 10-year Commonwealth Bond rates of 0.85% per annum and inflation being steered by policy makers to over 2%, this will invariably deliver investors negative real returns. A period of sustained suppression in bond rates is now firmly official policy.

How do Australian investors manage the end of the easy road/easy returns experienced for the last 30 years?

We portend that what Australian investors have liked for the last 30 years will, going forward, deliver negative or negligible real rates of return. That is:

1. Bond Market Fixed Income (Government, Investment Grade)
Investing in fixed rate bonds will no longer generate easy, low-risk equity returns. Avoid Government fixed bonds. Negative rates after inflation of 1.5% or more, are highly unattractive.

2. Residential Property
Collectively households have pushed valuations and leverage to the max, and we don’t think households will get a sustained lift in income to improve these valuation metrics. Again, the returns after inflation will either be near zero or negative.

The Path Ahead

We see three segments as providing reasonable risk-adjusted returns as part of a carefully constructed, diversified asset allocation structure:

1. Commercial Property
Subject to financial market disciplines and selected classes such as logistics and fringe CBD office, investors can receive 3% to 4% per annum real rates of return with modest volatility. This largely plays to the simple reality that Australia has become one big distribution centre.

2. Australian Equities
Look reasonably attractive compared to bonds. Whereas leveraged residential property boomed, Australian equities have “plumbed” along. That said, just because it’s cheap, doesn’t make it good value. We are always concerned where banks make up a disproportionate amount of the equity market. This still remains the case here in Australia together with mining, but as neither of these sectors represent excess valuation, then we can take some comfort. The key headwind is earnings, and after COVID impacts, the biggest risk is wage inflation. Again, we might expect 4% to 6% per annum real rates of return.

3. Non-bank Lending
As bank involvement in credit intermediation reduces, others step in and fill the void. The big four banks will remain, but as occurred in the US some 30 years ago, Australian banks will be of diminishing relevance and size in financing the Australian economy. We will consider opportunities in well-considered, well-structured and secured credit income opportunities, an area where banks are simply not prepared to do the due diligence leaving the mid-market under-serviced.

So solid positive real rates of return are available. Investors will need to constructively engage in risk and volatility as part of well diversified and structured portfolio. Previous easy returns from bond compression and leveraged residential property are the high risk strategies going forward.

Peace of Mind Investing

Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.

For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.