Bond buyers break all records

The boom in government bonds is now accessible to retail investors.

The Australian corporate bond market, by comparison with the US, has been fairly slow.

We are in the middle of the biggest government bond issuance program ever seen.

The federal government’s bonds issuance tally just since the start of March alone is now close to $65bn, which compares with the $49bn in bonds issued for the whole of 2019.

It’s all part of helping to pay for the massive $130bn in economic stimulus measures it has unveiled so far.

And Australia’s Treasury bond issues are steadily growing in size.

In mid-May the Australian Office of Financial Management – which manages the government’s debt portfolio – set a new domestic record when it sold $19bn of 10-year bonds through one issue.

The amount easily bettered the previous record of $13bn raised from a government bond issue in mid-April.

But what was even more extraordinary was the high level of global investor demand for Australian government bonds.

Issued at a yield of just 1.025 per cent, the December 2030 bonds issued on May 13 attracted a record $53.5bn worth of bids – almost three times the amount on offer.

Why is this happening? First and foremost, fixed interest investors around the world are seeking out high-quality bonds. And Australia is one of the few countries in the world still holding the highest credit rating of ‘AAA’.

Australian yields are relatively attractive in the current low interest rate environment, plus our weaker currency has been a sweetener for foreign buyers.

Strong demand

For retail investors, the strong demand in the bond market overall, putting aside the current exceptional events around COVID-19, underscores the important role that fixed interest plays in investment portfolios.

The activity also demonstrates that investors are heavily attracted to high-quality government and corporate bonds, which can be readily accessed through managed bond funds and listed bond ETFs.

Because of their primary function as long-term debt funding instruments, bonds are much less susceptible than shares to short-term market volatility and generally act as stabilisers in choppy market conditions.

Global bond funds and ETFs provide exposure to high-rated government and corporate issues, offering secure long-term income streams over the duration of each bond issue.

The surge in activity in Australia has been mirrored around the world with many governments also having to raise big amounts of capital through bond issues to fund their own COVID-19 economic rescue packages.

Large bond issues by other high-rated sovereigns in the last few weeks, such as the United States and Britain, also attracted unprecedented demand.

Despite the much-publicised recent volatility on fixed interest markets, caused by panic selling, investors are continuing to back the broader stability and lower risk of investment grade bonds.

The strong demand for government bonds is also being mirrored in investment grade corporate bond issues.

Much of the corporate bond action is taking place in the US, with the Federal Reserve Bank having just launched the first stage of a $US750bn corporate bond buying program it announced in March.

Focus on exchange traded funds

The Fed’s bond buying program is focused on exchange traded funds that invest in corporate debt issues, with its main objective to support trading activity in the bond market by injecting government funds into ETFs.

The bulk of the Fed’s funding will be in ETFs that invest in investment grade corporate credit (bonds rated between ‘AAA’ and ‘BBB-’.

A second component of its program will involve buying corporate bonds directly, and this may involve issues by so-called “fallen angel” companies that had previously been rated as investment grade but have since been downgraded to high-yield status due to the coronavirus crisis.

The Fed’s announced buying program has already fuelled a surge in new US corporate bond issues, totalling a record $US300bn ($459bn) in April.

The Australian corporate bond market, by comparison with the US, has been fairly slow.

Yet, that’s changing. It’s now also showing signs of life as more companies move to raise capital to strengthen their balance sheets.

This month supermarkets group Woolworths attracted strong investor buying when it launched a $1bn bond issue, split into five and 10-year maturity tranches. The Woolworths issue followed the launch of an $860m bond program by Telstra late last month

While bonds can experience low to negative returns in the event of rising interest rates, the reinvestment of income payments and the benefit of compounding means investors with a medium to long time frame may eventually better off holding bonds.

Tony Kaye is senior personal finance writer with Vanguard Investments Australia.

vanguard.com.au