Vanguard | 30 April 2013

Suggestions that bond market bubble conditions exist can be misleading, and shouldn’t call into question the value of bonds in a portfolio, according to Low yields and rising rates concerns: the implications for bond market investors. a new whitepaper published today by Vanguard Australia.

The global fall in interest rates to very low levels following the 2008 financial crisis has provided fixed income investors with significantly above average returns, leading to suggestions of a bond bubble that could burst if yields start to rise rapidly.

The paper, authored by Rosemary Steinfort, Investment Analyst, Vanguard Australia, demonstrates that the characteristics of fixed income assets and the enduring role that they play in providing income, capital stability and diversification in a portfolio despite these concerns.

The paper describes why bond returns respond efficiently to changes in interest rates and have a well defined income stream. In addition the transparency of central banks and inflation targeting policies reduces the likelihood of unexpected large interest rate adjustments.

Speaking about the paper, Greg Davis, Chief Investment Officer, Vanguard Asia-Pacific said:

Bond markets operate differently to equity markets and this paper confirms that in reality a bond market bubble in the same context as we might define an equity market bubble is not possible.

By splitting the performance of a bond into income and price, we can distinguish that over the longer term, income will have the greatest impact on returns regardless of interest rate fluctuations.

The key considerations for any prospective bond investor are related to their motivation for investing in bonds — if you are investing in bonds for their income or diversification properties, then you should not be concerned about changes in interest rates.

However if you are investing in bonds because of past high performance, then you need to be realistic in your expectations, the next 10 years are unlikely to look like the past 10 years, said Mr Davis.

The paper concludes that, in the main, investors should not view a bond bear market with the same level of apprehension as an equity bear market.

Furthermore, a balanced diversified portfolio incorporating good quality defensive and growth assets should produce attractive risk return outcomes for investors over the long term, irrespective of interest rates.

The full whitepaper Low Yields and rising rates concerns: the implications for bond market investors can be accessed here .