Why sovereign bonds hold enduring appeal

-- | 18/06/2019

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Glenn Freeman: We're here on the sidelines of the Morningstar Investment Conference. I'm speaking today with Keith Lloyd from Colchester Global.

Now, Keith, you were speaking today in a panel that was looking at defensive assets in a low-yield world and you are looking at global bonds. Now, what are some of the characteristics there that make them stand out in your mind?

Keith Lloyd: Sure. I mean, when one is looking for defensive assets, you're really looking for assets that are going to go up when everything else goes down and in particular, when your equities and your sort of growth-orientated assets go down. What history shows you is that cash doesn't do that. Cash just gives you whatever the rate of return is and also, it's a lot of the assets such as infrastructure, hedge funds, so on and so forth, they typically go down at a point of stress. So, it's really only bonds and in particular sovereign bonds that actually go up at that point of stress. So, it's really them that give you the true underlying defensive structure.

Freeman: Sure. And you were comparing and contrasting the appeal of global bonds versus the domestic bonds in this market.

Lloyd: That's true. So, typically, again, what history has shown you is that actually at those points of stress such as say the European banking crisis or the Global Financial Crisis, global bonds hedged back here into the domestic Aussie dollar or even unhedged actually had significantly outperformed local domestic Aussie bonds. Given where valuations are too, given the very sharp drop in nominal yields which has taken place here and given what really is a pretty much an unchanged inflation outlook, you're really starting to look at negative real yields here, which is the first time for many years and quite so deeply negative. You're looking possibly about a half of a percent negative real yield. So, for us, when we're looking around the world, we're seeing countries that are offering you positive real yields such as AAA-rated Singapore or the U.S. treasury market is even offering around about 0.5 per cent real yield positive. So, I'm looking at the two, I'm seeing much better value elsewhere.

Freeman: Sure. And that's one of the points that you focus on purely on sovereign bonds. So, those markets that you prefer. What are some of the other standouts?

Lloyd: Well, you've really got to go into some of the sort of lower credits. So, you can think of countries like the Polish bond market which really isn't an emerging market in the true sense of the word. I mean, it's highly integrated with Germany it has tried to make a move in the Middle Europe, strong A-rated countries. So, Polish bond market looks good. Whereas in contrast, we would venture that a number of the European markets aren't looking as strong. So, you can think of the sort of core Europe or even the UK bond market where you're looking at minus 1 per cent to minus 1.5 per cent real yield in both of those markets. So, whilst one should go global, one doesn't necessarily just go global in a passive sense or sort of buy just the sort of major markets. You need to build a very diversified portfolio.

Freeman: Sure. Thank you very much for your time.

Lloyd: Sure. Thank you very much.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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