What record low bond yields mean for investors

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<p><strong>Glenn Freeman</strong>: In this this edition of "Ask the Expert" I'm speaking to Brad Bugg from Morningstar Investment Management.</p> <p>Brad, thanks for your time today.</p> <p><strong>Brad Bugg</strong>: Glad to be here.</p> <p><strong>Freeman</strong>: Now, Brad, we're talking about the 10-year government bond, which just last week, we've seen it dip down into historic low of below 1 per cent. Can you just explain for us what this means for investors and what's actually driven it to this point?</p> <p><strong>Bugg</strong>: Yeah, we've seen the bond yield drop below 1 per cent, which is a record low here in Australia, but it's really in response to what was going on around the rest of the world. Central banks everywhere are looking like they're going to be cutting rates over the foreseeable future. And that's really in response to concerns around global growth, which are coming from concerns about the trade war, as well as inflation remaining persistently low. So, central banks feel that they need to stimulate activity around the world, and they're doing that by cutting interest rates.</p> <p><strong>Freeman</strong>: And is this a continuation of this sort of screwy correlation we've seen between fixed income and equities where they're actually moving in the same direction.</p> <p><strong>Bugg</strong>: It has been a bizarre period. Typically, we would expect equity markets and bond markets to move in opposite directions. What I mean by that is, sort of, if you've got strong growth in the economy, that should flow through to increased share prices, because their profits will increase. But at the same time, that will be reflected in bond markets by higher expectations of inflation and growth, which typically around comes through in higher bond yields. But what we've seen is, bond yields have been going down, and equities have been responding to that. And that's really is their response because of lower discount rates, meaning sort of as you bring future profits back to today, it's worth a lot more.</p> <p><strong>Freeman</strong>: And what's Morningstar Investment Management's long-term view on these bond yields?</p> <p><strong>Bugg</strong>: I mean, we feel that these rates are probably unsustainable over the longer term. That's not to say that they could go lower in the shorter term. The RBA is talking about the potential to cut rates further from where we are already, and other central banks are talking about the same thing. So, I think what we might see from here is that interest rates will sort of stay around these very low levels, but in the future, we would expect them to push higher.</p> <p><strong>Freeman</strong>: And this isn't something that's &ndash; it's not something isolated to Australia, we've seen sovereign bonds falling around the world as well, haven't we?</p> <p><strong>Bugg</strong>: That's right. And Australians are actually quite fortunate. While they might be moaning about sort of only getting 1 per cent on a 10-year government bond, that's quite a bit higher than what we're seeing in Europe and Japan. In many instances, those interest rates are negative. So, the 1 per cent we're getting here is bizarrely quite attractive.</p> <p><strong>Freeman</strong>: And just finally, I mean, does this change the role that fixed income, or say, sovereign bonds or corporate bonds have in people's investment portfolios?</p> <p><strong>Bugg</strong>: Ultimately, we think in a multi-asset portfolio, they will be diversifiers when things do go bad. But we just don't think they'll be able to provide the same sort of diversification and protection as they may have done historically. Because if you think back to what happened in 2008, when we had the great financial crisis, we saw interest rates in Australia fall 3 per cent, 4 per cent and that provided a meaningful offset that we were seeing in equity markets. We think to provide that same offset you're going to need to see interest rates fall into negative territory to provide that diversification benefit. And we just don't think that's possible.</p> <p><strong>Freeman</strong>: Great. Thanks for your time today, Brad.</p> <p><strong>Bugg</strong>: Thank you.</p>

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