Is your money better off in the bank?

Last year, your money would have done better in bank vaults than in many other fixed interest securities. Zilla Efrat investigates whether it’s safe to put your toe back into the murky waters of the bond market yet.

Last year, your money would have done better in bank vaults than in many other fixed interest securities. Zilla Efrat investigates whether it’s safe to put your toe back into the murky waters of the bond market yet.

Despite years of solid returns, the fixed interest market was not the most attractive place to be in 1999.

The benchmark Warburg Dillon Read Composite All Maturities Fixed Interest In-dex was down 1.2 per cent over the year. And, according to van Eyk Research, the one year return for the average retail Australian Fixed Interest Trust was negative 1.38 per cent.

Last year may have kicked off with fears of global deflation, but it ended, instead, on the back of buoyant economic growth and concerns about rising inflation, all of which placed upward pressure on bond yields.

AMP chief economist Shane Oliver says the story was the same with bond yields rising the world over, except in Japan. Indeed, the Salomon Brothers World Bond Index for international bonds showed a meagre 0.9 per cent return for the year.

One of the worst places to have been was in income securities. Income securities are basically floating-rate debt securities which offer high yields and are issued by high-quality household company names like Woolworths, AMP, Macquarie, Colo-nial and National Australia Bank. At first, investors pumped over $5 billion into these products. Then things soured as awareness of their risks grew.

With these investments now languishing below their issue prices, investors could be in the red to the tune of an estimated $400-500 million. But just who loses out is yet to emerge.

Only those fixed interest investors who went for safe cash, Japanese bonds or listed corporate bonds had anything to smile about.

Indeed, listed corporate bonds are one of the fastest growing areas of the fixed in-terest market because they offer higher yields (because of the risk associated with them) and are of shorter duration.

According to Tony Lewis, managing director of Sydney-based fixed-interest secu-rities company Lewis Securities, these rewarded buyers with yields of more than 9 per cent (and in certain cases even 20 per cent) in 1999.

Oliver says that if you are already invested in fixed interest and have been through the pain of last year, you are better off staying there because the bulk of the bear market in bonds has passed.

“The long term view of inflation in Australia is that it will stay low and there are still some deflationary pressures coming from new technology advancements,” he says.

And, despite last year’s drubbing, those who are not already in the fixed interest market should also not ignore it this year. That is not only because its products of-fer solid diversification benefits, but also because they sit well in risk adverse port-folios and can generate regular income for those who need it.

Lewis and others believe that bonds have been oversold and that the market has factored in more than enough for fixed interest rises.

“Almost everyone is sitting on the fence right now because they believe that they will get better rates later. I think that they will just get a sore bottom,” he says.

Most pundits expect the fixed interest market to offer positive returns this year, al-though nothing spectacular.

Inflation is always bad news for debt markets, but Oliver says: “The fact that the Reserve Bank of Australia is working decisively tells us that it will not be a bad year for bonds.”

He notes that the RBA recently hiked up the cash rate by 50 basis points (and not by 25 points the market was expecting) to keep inflation firmly in check.

Janice Sengupta, head of research at Godfrey Pembroke, says opportunities can often be found in apparent adversity.

“Many investors remember how harrowing 1994 was when it felt as though bears were clawing the life out of the market. The bond market, which is typically viewed as a ‘safe’ market relative to shares, experienced carnage,” she says.

She says when the sentiment was the darkest in mid-1994, yields were pushed far above fair value. Some investors were scared away from the bond market then and have stayed away ever since.

The opportunity costs of being out of the market altogether would have been great during the upward trend in bond prices (decline in yields) over the subsequent four years, Sengupta says.

However, Oliver believes investors are probably better off in cash in the first half of this year.

“By the second half, the RBA will get close to the peak of the tightening cycle and bond rates may start to fall,” he says.

Head of cash and fixed interest at Macquarie, Wayne Fitzgibbon, expects a con-solidation in the bond market in the first half of this year, but says there may be gains to be had towards the end of the year.

“We think that the worst is behind us… Globally, inflation isn’t really such a problem. Central banks around the world are increasing interest rates which slows inflation down,” he says.

From an asset allocation point of view, Macquarie is currently neutral on fixed in-terest, after being underweight towards the end of last year.

Some experts — but certainly not all — believe income securities may turn to be a good investment (as soon as their tax status is resolved by the Australian Tax Of-fice). This is mainly because they are trading at discounts to their issue prices but also because they still offer a good rate above general interest rates.

The number of government bonds in the market is shrinking — and is likely to con-tinue to do so - as the government pays off its debt, continues its privatisation pro-cess and runs budget surpluses.

That’s good news for fixed interest investors over the longer term.

“It’s a case of demand versus supply. People will want to buy safe securities but there will be less to buy,” Lewis says.

In the meantime, corporate bonds have been filling some of the gap left by the public sector. And, their prospects for this year appear to be fairly bright.

“Corporate bonds could provide reasonably good returns this year because they start off with higher fixed interest yields than other fixed interest products,” Oliver says.

AMP expects conventional bonds to produce returns of around 6 per cent this year while cash could bring in about 5.5 per cent. Corporate bonds could do slightly better than both.