Global Bonds – a rising star?

While international equities continue to test investors’ patience, bonds are the quiet achievers. TOWER’s Michael Coote takes a look at the reasons behind the rise of the international bond market.

Sharemarkets are hogging the headlines as uncertainty drags them down over company performance, economic disruptions, and war fears over Iraq. Comparatively little attention is being paid to the simultaneous bull market in bonds. Although they attract less public attention than sharemarkets, bond markets worldwide – both sovereign and corporate – are representing a greater total amount of capital. In just the same conditions that kill off shares, bonds can flourish.

Bonds pay fixed rates of interest and are usually reliable income sources, especially if issued by governments. But like shares, bonds have both bull and bear markets because once issued they may be freely bought and sold, which permits prices to change. Primarily, bond values are driven by short-term interest rates. The capital value of bonds moves inversely to the trend for interest rates.

The effect of official interest rate changes can be extreme for bonds, but interest rate changes alone are not the full story with bond pricing. Supply and demand plays its part. In periods of economic buoyancy, shares are more popular than bonds because investors prefer dividends to usually lower interest rate payments. But in times of economic weakness, such as we see at present, bonds are more sought after than shares due to investors wanting greater certainty of income payment from interest as opposed to unpredictable dividends.

When crises occur, such as September 11 and US-led aggression towards Iraq, bonds benefit further as a flight-to-safety investment akin to gold. While we read in the newspapers about sharemarkets plummeting on Iraq fears, bonds are headed upwards in the opposite direction. When investors are afraid or uncertain as to what to do, they buy investments like bonds.

The well-planned portfolio should have not only a mix of bonds and shares, it should also have internal diversification within the same asset class to reduce correlation further. Just as a good portfolio holds a mix of New Zealand shares and international equities, so too should it contain a combination of New Zealand fixed interest and overseas bonds. The chart below shows an efficient frontier graph which suggests that a good fixed interest mix would be 25% New Zealand and 75% overseas.

One good way to get overseas bond exposure to complement New Zealand fixed interest and round out a low-correlation portfolio of diversified assets is the TOWER BondPlus Fund. BondPlus is managed by PIMCO (Pacific Investment Management Company – see www.pimco.com), a top, multiple award-winning international bond fund manager. PIMCO is an aggregate bond manager, meaning that it actively trades in both public and private debt in order to squeeze out some extra yield. BondPlus is ideal for investors who need international diversification, not only because of the quality of its returns, but also because it is fully hedged to the New Zealand dollar, cutting currency fluctuations out of returns.

For further information or for copies of the Investment Statement, talk to your TOWER Business Development Manager or contact TOWER via email on investments.tmf@nz.towerlimited.com on 0800 4 TOWER (0800 486 937).
Please note: This information is intended for adviser-use only. Please be aware that the content of this presentation is not a securities recommendation and it does not contain securities advice.

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