Investors should not be worried about a bubble in the bond market, as the current high prices and low yields in bonds are not driven by the same factors as a classic bubble, says Roger Bridges, head of fixed income at Tyndall AM.
“The definition of a bubble is a price level that is much higher than is warranted by the fundamentals and by what rational expectations would dictate.
“In essence, bubbles occur when prices continue to rise because enough investors believe that they can buy securities at the current price and then sell them at even higher prices.
“However, the key drivers for the current bond market prices and yields are not the same ones that create a bubble situation, and investors should rest assured that the current market environment will remain supportive of bonds,” Mr Bridges said.
He said there are three main reasons why these assets should remain attractive for the foreseeable future.
“Firstly, the flow of money into the bond market is not being fuelled by greed, as is the case in a classic bubble scenario, but by flight-to-safety.
“You could say that in the current environment investors are worrying more about the return of their capital than on their capital.
“In addition, foreign investment is playing a huge role in the price of Australian bonds. Before the global financial crisis (GFC), approximately 20-30% of Australian government bonds were held offshore. By 2012, this number had jumped to around 80%.
“With countries previously viewed as safe havens experiencing extreme turmoil, Australian dollar-denominated assets are benefiting from central banks’ impetus for diversification away from currencies such as the US dollar, and this is helping drive bond prices higher.
“Secondly, loose monetary policy in other developed economies is driving demand for our bonds.
“Central banks around the world (the main three being the US, Japan, and the UK) are attempting to boost growth in their nations and accelerate economic recovery by using quantitative easing (QE).
“The aim is to increase the central banks’ excess reserves, raise the prices of the financial assets they are buying, and thus lower their yields.
“For Australia, this artificial suppression by other central banks means that there is increased demand for our higher yielding assets. Given that QE is likely to continue for some time as these countries’ economies recover, it is difficult to see the attractiveness of Australian bonds diminishing in the near future.
“And thirdly, investors are not looking to sell their bond investments any time soon.
“Although at Tyndall we think that yields on Commonwealth government bonds are currently below fair value, investors on the whole are not buying these bonds in order to sell them at a higher price.
“Despite recent rate cuts, Australia’s government bonds remain the highest-yielding AAA rated assets in the world. Prices for our Commonwealth government bonds may be historically high and yields historically low, but compared with the rest of the developed world they remain attractive.
“This yield differential has quite a bit further to contract before it starts becoming unattractive to offshore investors.
“In the near to medium term, Australian bonds will remain attractive. With the US and France losing their AAA status and several of the remaining AAA rated countries looking shaky, Australia’s position is stronger than ever,” Mr Bridges said.
Tyndall AM is a multi-specialist Australian investment manager, offering investment funds in Australian shares, Australian and international fixed interest, and alternative assets, as well as a multi-manager capability to retail and institutional investors in Australia. It has over A$22 billion in funds under management (as at 30 September 2012).
Tyndall AM is a wholly owned subsidiary of Nikko Asset Management Co., Ltd., one of the largest asset manager headquartered in Asia with approximately A$148 billion in funds under management (as at 30 September 2012).
For more information please contact:
Roger Bridges – Phone: 02 8072 6350
23 January 2013