Cash Gains Slight Edge On Government Bonds

0
Cash Gains Slight Edge On Government Bonds

In a quirky reversal, the big, bad banks of Royal Commission days are now being asked to don their Avenger capes and come to the rescue of businesses and individuals caught up in the savage coronavirus whirlwind.

While deferring payments and extending credit, encouragingly, they have also increased term deposit rates.

The biggest business lender NAB, is leading the four majors with a 1.75 per cent pa rate for a 10 month term deposit. CBA is showing 1.30 per cent pa for eight months and 1.70 per cent for a year. ANZ has also come to the party offering 1.35 per cent pa for eight months. Limits apply.

Westpac has a more comprehensive offering but is last to come to the market with these rates available from 27 March 2020. Its one year rate is 1.7 per cent with interest paid monthly.

Moreover, Westpac has added an innovation – for Australians aged 65 years and over, the rate is a high 2 per cent p.a. for eight months – both options up to $500,000 per customer.

For conservative investors the limited but clear trend of banks beginning to life term deposit rates towards more acceptable levels is worth noting. Put simply these attractive deposit rates make government bonds less appealing.

Indeed, Australian government bond rates look meagre in comparison. Since quantitative easing began, short term rates have been pushed down towards the RBA target of 0.25 per cent out to three years. After three years, they rise steadily to approximately 0.90 per cent for ten years. With little prospect of negative interest rates and the resultant price appreciation for the bonds, deposits remain the better yielding alternative.

Still, investors need always to consider diversification.

Government bonds are key defensive assets in the world’s largest portfolios. Most large institutional investors have mandates requiring minimum investments in global AAA rated sovereign bonds. The Australian government is one of only a handful of sovereign issuers to meet the hurdle.

When financial markets deteriorate, institutional investors flock to ‘safe haven’ government bonds, but few private investors understand the benefits.

Government bonds tend to outperform when prices of other assets decline. The bonds offset losses and help to cushion your portfolio from the turmoil. As markets are generally unpredictable, government bonds provide unrivaled protection.

There are a range of government bonds listed on the ASX and there are dedicated government bond ETFs and others with a majority holding.

Just now there are opposing views as to whether it’s worth investing in the market.

Arguments in favor of investing in government bonds point to these features:

  • Safe haven asset where bond prices can increase providing an unexpected gain if sold prior to maturity.
  • Performance is not tied to the economic cycle. Sovereigns print money and collect taxes ensuring the $100 face value of the bonds is repaid at maturity.
  • Investors have a much-prized government guarantee.
  • Income is fixed and paid half yearly, providing great certainty.
  • Australian government bonds are highly liquid. Investors can sell if they need to access funds at short notice.

Reasons against

  • While the RBA has committed to buying bonds along the curve to support the market and has been effective in the early days, when the commitment to 0.25 per cent, three year government bond yields was announced, the 10 year yield spiked. The market was hoping for a formal target for 10 year bonds as well. The dislocation shows there can still be volatility in very low risk government bonds, although I expect with central bank intervention this should ease.
  • Projections to support the economy through the pandemic are underestimated and greater assistance requires greater government bond issuance.
  • Very low yields to maturity.
  • Potential for interest rates to rise and the face value of the bond to decline.

Gary Norden, a hedge fund manager at NN2 Capital, who has worked in global fixed income markets thinks the government should consider tax incentives for investors to buy government bonds. Norden says, ‘there has long been incentives for Australian investors to buy shares, with this nation changing event and government debt skyrocketing, we need to explore the potential for investors to be offered tax incentives to invest in Australian government bonds.’

As published in The Australian on 7 April 2020

Previous article Reserve Bank of NZ Adds to Australian Bank Dividend Pressure
Next article Government Bond Basics
Elizabeth Moran
Editor In Chief
Elizabeth is a nationally-recognised independent expert on fixed income. She has more than 25 years experience in banking and financial institutions in Australia and the UK and has been published in every major Australian newspaper and investment website. Prior to becoming an independent commentator in 2019 she spent more than 10 years as the head of education and research at fixed income broker FIIG Securities. Prior to joining FIIG, Elizabeth worked as an Editor/Analyst for Rapid Ratings a quantitative credit rating agency. She also spent five years in London, three working as a credit rating analyst for NatWest Markets.

LEAVE A COMMENT

Please enter your comment!
Please enter your name here