Interest rate cuts good for bond investors – at least for a while

Bonds were shaken, stirred and spat out in the past couple of years amid rising interest rates, but experts expect a good 2024.

Bonds and other fixed income investments had a stuttering recovery last year after their horrors of 2022, but 2024 is looking good for this often-misunderstood asset class.

Investment specialists say many bond yields are now between 5 per cent and 7 per cent, and capital gains could come this year from interest rate cuts in the US, Australia and elsewhere.

“After some tough years, we see a positive outlook for fixed-rate bonds,” William Buck wealth advisory director Adrian Frinsdorf said.

“These defensive assets are well placed to outperform the market in 2024,” he said.

Fixed income investments include government and corporate bonds, mortgage-backed securities and insurance linked securities, which are linked to weather events and transfer risk from reinsurers to investors.

Adrian Frinsdorf from William Buck says bonds had an image problem. Picture: Supplied

Mr Frinsdorf said bonds were historically under-appreciated and misunderstood by average Australian investors.

“Investing in bonds is essentially lending money for a fixed term to a government or corporation,” he said.

“In effect, it allows the investor to be the bank.

“Almost all government bonds are issued as fixed rate. Traditionally when interest rates rise, the price of fixed rate bonds fall and vice versa.”

This is why 2022 was so painful for bonds despite their conservative nature. As central bank interest rate rises went from near-zero to multi-year highs, bond funds suffered their worst returns in decades – shocking and disappointing many retirees and other conservative investors.

American Century Investments has forecast rate cuts and a US recession this year, and says this could benefit fixed income investors.

“While recessions often trigger market anxiety and uncertainty, they also may reveal some potential silver linings for bond investors,” said its co-CIO John Lovito.

“Bonds have historically tended to perform well in periods of falling interest rates, benefiting from the price gains that accompany declining yields,” he said.

The downside, however, is that lower interest rates mean lower long-term bond yields.

Fixed income investment app Blossom doubled its fund under management last year to $50m amid surging interest in bonds, and it aims to double FUM again this year.

Blossom co-founder and chief executive Gaby Rosenberg said the business had “worked hard to democratise access to bonds” and its targeted returns of 5.95 per cent helped drive its growth.

“Some investors are looking forward to the chance of interest rates decreasing … following a period of rate increases,” she said.

“This change in monetary policy could make fixed-income investments appealing because lower rates can lead to higher bond prices.

Blossom CEO Gaby Rosenberg says demand for bonds could climb. Picture: Supplied

“Demand for fixed income is expected to remain stable or possibly increase in 2024.

“Returns on fixed income are expected to be competitive and appealing in 2024, particularly when compared to other low-yield assets such as cash. It is anticipated that bond yields will decrease, potentially leading to capital gains for investors.”

Mr Frinsdorf said bond markets were larger than share markets but the historical issue for Australian investors had been access.

“Corporate bonds are only available at a $500,000 minimum buy-in and only recently have government bonds become available via the ASX in small parcels,” he said.

“There are some good quality exchange-traded funds and managed bond funds that can provide exposure for the average investor.

“We would suggest retirees consider a significant proportion of their investment portfolio is comprised of bonds and fixed interest, for example around 30 per cent.”

Originally published as Interest rate cuts good for bond investors – at least for a while