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Govt bonds still attractive, but care needed

Government bonds

Government bonds are still a good source of returns as interest rates remain low, but post-COVID-19 economic activity will make careful management of them important for investors.

Investors using government bonds will continue to benefit from low interest rate, but will still need to actively manage their place within a portfolio in the near future as economies recover from the COVID-19-driven downturn.

Janus Henderson head of Australian fixed interest Jay Sivapalan said the release of the investment manager’s first global index of government debt found world governments had taken on higher levels of debt as a result of the coronavirus pandemic.

This included Australia, which added $211 billion to its national debt in 2020 for a total debt of $1021 billion, and while this capped off a period of growth in government debt over the past 25 years, it was offset by economic growth.

Janus Henderson noted Australian government debt had grown at the same rate as that of the United Kingdom since 1995, but a growth rate of 257 per cent for the economy – three time faster than the UK – meant the debt to gross domestic product level was half that of the UK and 30 percentage points lower than the world average of 84 per cent.

“The figure is among the lowest in the world and places Australia in the company of its Asian neighbours South Korea and Hong Kong,” the manager noted, adding that despite this growth, the pandemic led to a budget deficit of 7.3 per cent last year.

Janus Henderson pointed out low interest rates meant this debt was cheap to finance and global governments had to pay only 2 per cent for their loans in 2020, compared to 7.6 per cent in 1995.

At the same time, the long-term decline in interest rates since 1995 has created solid returns for bond investors, but Sivapalan said the COVID-19- driven market downturn may have been the bottom of the cycle.

“Investors have enjoyed superb returns from bonds in recent years, with Australian government bonds particularly strong performers,” he said.

“However, record-breaking lows in bond yields within the context of 400-plus years of bond market history are now behind us.

“Risk-free rates will begin to trend upwards gradually over the coming decade as central banks and governments err on the side of creating a slightly higher level of inflation than perhaps they’ve targeted in the past.

“At times, the moves in bond yields can be brisk as we have observed this year. Stronger economies tend to be bad news for bond prices and as such it’s prudent for investors to actively manage interest rate risk over the years ahead.”

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