Investors oblivious to evolving bond risks

Investors could be exposing themselves to higher levels of risk and jeopardising their retirement savings by failing to monitor their fixed income investment strategies and not appreciating the dramatic changes to the sector in recent years, a specialist bond manager has warned.

Many investors view bonds as low risk and as an asset class to supplement more aggressive strategies in other assets classes. However this is an outdated view according to Tyndall Investment Management, which argues such investors fail to appreciate the far reaching changes to the sector in recent years.

“About six or seven years ago the corporate sector represented less than six per cent of the benchmark, four years ago it exceeded 20 per cent, and now it comprises 33 per cent of the benchmark,” Tyndall executive bond manager Ros Gustafson told delegates attending the Association of Superannuation Funds of Australia (ASFA) annual conference last week in Adelaide.

Gustafson went further by suggesting that “in a couple of years”, corporate bonds would account for the majority of the UBS Composite Bond Index with government and semi-government backed bonds slipping below 50 per cent.

“Many investors take the view that they are doing the right thing by having a balanced investment portfolio with a percentage in bonds. But they don’t realize what currently makes up the bond component or that the benchmark index is not the ‘traditional and safe mix of commonwealth and semi-government bonds’ it used to be,” Gustafson said.

According to Gustafson, most investors adopt the strategy whereby the bond component of their portfolio is passively managed with the more active component of the portfolio allotted to growth investments in other asset classes.

But Gustafson said this approach was problematic given the changing nature of the fixed interest market.

“Such an approach has two serious flaws, one affects the risk in their total portfolio and the other the earnings capacity of the portfolio to deliver superior longer-term earnings for the investor,” Gustafson said.

Some of the other risks identified by Gustafson included a lack of diversity across economic sectors and many sub-sets of credit classes being driven by a thin collective of borrowers.

He said many investors faced “double-jeopardy” by owning stocks and bonds for the same corporation. This will be compounded by the departure of News Corp from the Australian market, as it increases the weighting of the major banks and Telstra in both the equity and bond indexes and many investors are exposed to both markets for each of these companies, Gustafson said.