News & Commentary

Behold the beauty of bonds 16 Dec 11

It is a time for celebration.

In a year of gloom and doom that many investors will be happy to say farewell to the humble bond fund once again came to the fore, a place not only of safe harbor but also of solid return.

For share investors 2011 was a year that started with a lot of promise but turned sour even before the year was half over and then took on the characteristics of a pin ball whenever another European debt summit was meeting trying to thrash out a political solution to the region’s fiscal woes.

At the end of November the Australian sharemarket had lost 9.6 percent as measured by the S&P/ASX300 index which is no doubt perplexing to most Australian share investors when you consider what a standout the Australian economy and government debt position is compared with the rest of the developed world yet international share markets were down only 5.5 percent according to the MSCI World ex-Australia index. If you had hedged the currency factor the international shares result improved even further.

For investors looking for capital growth 2011 was certainly a disappointment. But for investors looking for security and yield the situation was quite a different story.

For a start term deposits were a popular safe haven with money flowing in to take advantage of rates between 5-6 percent and the comparative safety of the banks.
But the standout performers for 2011 were Australian Government bonds. The UBS Australian Government Bond index shows a return of 11.7 percent for the calendar year to the end of 2011. It is made up of bonds issued by both federal and state governments.

The broader UBS Australian composite bond index that is made up of government, semi-government and corporate bonds was not far behind with a positive return to the end of November of 10.5 percent.

So conservative, risk averse investors have had a happy end to 2011 despite the ongoing concerns about the debt and economic situation in Europe and other parts of the world.

But the performance results of 2011probably offer two lessons as people perhaps turn their mind to a portfolio review in January once the festive season is out of the way.

One is that these type of returns from fixed interest funds are clearly a result of the unusual global economic situation and in particular the uncertainty and if ever there is a time to heed the warning that past performance is no guide to future returns this would be one of them.

The second, more fundamental learning goes to the importance of the asset allocation decision and the value of fixed interest and its real role in your portfolio’s makeup.

This year has again reminded us of the power of the asset allocation decision. To make the point in an extreme way anyone invested 100 percent in the Australian sharemarket – regardless of how good a stock picker you are – the chances are you have had a tough year.

If you were invested 100 percent in Australian fixed interest it has been an outstanding year.

But who knows what next year holds? Certainly chasing last year’s top-performing asset class is fraught with danger.

Consider the best recent example of 2008 and 2009.

In 2008 the global financial crisis bared its teeth dramatically. The result was the Australian sharemarket S&P/ASX300 index was down 38.9 percent. By contrast the Australian fixed interest market measured by the UBS composite index was up 14.9 percent for the calendar year.

Step forward into 2009 and the sharemarket came surging back with a 37.5 percent positive return while the fixed interest market was flat with a 1.7 percent return for the year.

That is not to suggest the same will happen into 2012 but rather to emphasise the point that no-one really knows what will happen in the future and that investors who take an extreme view – be it all in shares or all in fixed interest are taking on a lot of risk.

The good news is that you can control the risk with your asset allocation decision – how much are you comfortable with in shares? How conservative do you want to be given your age with fixed interest? After all one year is a very short time horizon in the context of a lifetime of investing for retirement.

Perhaps the key lesson from 2011 is that the basic, some might say timeless, investment principles of diversification and a balanced portfolio held true this year and will hold people in good stead as we welcome in the New Year.

* Written by Robin Bowerman, Principal, Corporate Affairs & Market Development at Vanguard Investments Australia.
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