Bonds open new world of opportunity

The demand for bonds from superannuating funds has outstripped supply, says Van-guard Investments principal Eric Smith.

"Australian governments have been good at reducing debt and that has limited in-vestment opportunities for funds to invest in fixed-interest bonds," he says

According to research by Vanguard and Rainmaker, the projected demand for bonds will reach $150 billion by 2005, while Australian government debt will be at be-low $20 billion by that time.

Australia is now a very small player in the world bond market; it accounts for 1.8 per cent of the Salomon Smith Barney World Government Bond Index. Local funds are now looking offshore for future investments.

In the past, most bonds were issued in US dollars, but this has now fallen to 50 per cent of the total market, says Ian MacKinnon, managing director of the US-based Vanguard Group.

The US bond market is worth $US10.5 trillion, with the next-largest market being Japan, with $US3.5 trillion.

Speaking in Melbourne last week, MacKinnon says global capitalisation, with dif-ferent emphasis on risk and safety, is driving investors to look beyond their traditional home markets for opportunities.

"Foreign capital is moving to the US in search of safety while US capital is moving abroad in search of yield," he says.

To meet the demand for bonds globally, many companies that have become interna-tional players are issuing bonds in countries outside their home base. The bonds are issued in the local currencies which are hedged.

Investors looking globally have led to the emergence of indexed bond funds, MacKinnon says. In the US, indexed bond funds last year accounted for $US16 bil-lion out of a total market worth $US267 billion.

To capitalise on this market, Vanguard in Australia has launched a fixed-interest indexed bond fund which has attracted $38 million of funds under man-agement since its launch in late July.