Is the worst over for bond performance?

2022 will be remembered as one of the “worst bond routs in history”, according to Zenith, but it is looking like the worst is over when it comes to performance.

In a report on Australian fixed interest (AFI), the research firm said the median manager in the Zenith Australian fixed interest bond category had lost 7.8% over the year to 30 April, 2022. This compared to losses of 7.4% by the Bloomberg AusBond Composite index (0+ years) benchmark.

“The year will be remembered as one of the worst bond routs in history, as markets were battered by a barrage of economic developments and inflation emerged as a key risk for bond investors,” the report said.

“With the sell-off in domestic fixed interest markets, the sea of red ink was a painful reminder of how the risk/return payoff of investing in bonds has changed over the past two decades. The last time we experienced such a calamity was in 1994 when the Australian bond market retraced by approximately 8% from January to October.”

However, Zenith was optimistic that the “worst of the pain might already be behind us” and the current market environment could present an opportunity to add yields into client portfolios.

Future rate hikes, which were forecast to reach as high as 2.5%, would have a moderate impact on bond portfolios while the recent spike in bond yields had allowed managers to build yield buffers in portfolios which would likely provide positive real returns and inflation protection over the medium term.

Any potential impact on domestic bond markets from rate rises would be dependent on market sentiment and the Reserve Bank of Australia’s ability to provide forward guidance on the direction of future policy.

“From a portfolio construction perspective, with government bond yields rising by more than 250bps since 2020, the diversification benefits of allocating to AFI have improved. Based on Zenith’s Strategic Asset Allocation framework, our capital markets assumptions indicate an expected return of between 3% p.a. and 3.5% p.a. over the long term. Moreover, domestic bonds now provide a buffer against future yield spikes.”