Superannuation and pension fund warning: Low risk ‘won’t stop losses’

Bonds are seen as a boring investment but may soon deliver some unwanted excitement for many Australians. Here’s why.

A nasty surprise threatens to hit retirees and other low-risk superannuation fund members as interest rates in Australia and overseas begin to climb.

Negative returns loom – perhaps for the first time for some people – if their super or other investments contain a high proportion of fixed-interest assets such as government bonds.

Financial analysts and advisers say bond prices fall when interest rates rise, as increasing US inflation sparks fears that rate rises will come sooner-than-expected.

Many of Australia’s largest super funds have big bond exposures in their conservative and stable investment options, where 20 to 40 per cent is typically invested in fixed interest.

However, some funds are cutting back, including Hostplus which has no fixed interest in its default balanced option’s strategic asset allocation.

Wealth for Life Financial Planning principal Rex Whitford said fixed interest stabilised portfolios, but paid low incomes and “likely negative capital returns when interest rates start to rise”.

Cash squeeze. Conservative investors could suffer when interest rates start rising.

Some longer-term treasury and corporate bonds had already started to do this, he said.

“Fixed interest may not be the safe haven you think it is,” Mr Whitford said.

“In many cases, investors over-estimate the risk of shares but underestimate the risk of fixed interest. Especially at a time in history when the possibility of a negative return in fixed interest is very possible.”

Mr Whitford said there was a strong case for people to own a mix of fixed interest and shares.

Portfolio manager Chris Conway from investment newsletter Marcus Today said rising rates could cause losses from fixed interest investments, but “it’s not like investing in equities where in one year you can suffer a 10-to-15 per cent negative return”.

Mr Conway said bonds might deliver a year or two of returns that were “a couple of per cent negative” but trying to time the market was dangerous.

“The average investor, if they try and get too cute, will probably end up making a mess of it,” he said.

Vanguard head of fixed income Geoff Parrish said bond prices were “inversely related with yield – when yields go up, bond prices go down”.

That’s because a bond bought today that pays a low fixed interest rate is not as valuable as a bond bought in the future that pays a higher interest rate.

The last time Australian bonds went negative was in 1994, at minus-1.1 per cent as interest rates rose sharply. But bond returns were 10 per cent or more for the next four years, so patience paid off. US bonds were negative in 2017 when rates rose there.

Mr Parrish said higher interest rates would lead to higher incomes paid by bonds, and long-term investors should avoid trying to time the market if bond prices fell in the short-term.

“Don’t panic – stay the course … it’s hard to do,” he said.