For some of Australia’s biggest investors, a recession is a certainty and they’re buying bonds to position for the slowdown.
(Bloomberg) — For some of Australia’s biggest investors, a recession is a certainty and they’re buying bonds to position for the slowdown.
AustralianSuper Pty and Australian Retirement Trust, the nation’s two biggest pension funds by assets, favor buying bonds as a ballast against the impending economic downturn. The sovereign wealth fund, the Future Fund, has also beefed up its holdings of government debt.
“You want to buy bonds essentially when the yield curve is inverted, when the market thinks policy’s really tight,” said Mark Delaney, who helps oversee the equivalent of $182 billion as chief investment officer at AustralianSuper, referring to the debt market’s favored signal for a recession. “We’ve substantially increased our allocation of bonds,” he said. “We’ll just keep on buying at better levels.”
The positive view toward fixed-income assets stand out amid a wave of investors — many of whom also see recession looming — ditching bonds as the Federal Reserve and the European Central Bank signal ever higher policy rates to tame inflation. The question though is just how much protection debt markets will offer on the way to a downturn and the best strategies to navigate the harshest monetary tightening since the 1980s.
Bond investors are back in the spotlight after the best start to a year on record for debt markets unraveled in February as traders realized bets on pivots by central banks were premature. They have to find a balance between capturing some of the highest yields seen in decades and buying too much too early. They also have to contend with increasing market volatility as the collapse of Silicon Valley Bank spurred the biggest two-day plunge in short-maturity US yields since the collapse of Lehman Brothers Holdings Inc. 14 years ago.
For Ian Patrick, chief investment officer of Australian Retirement Trust, which oversees the equivalent of about $160 billion, the strategy is to increase the duration of some bond portfolios by between 50% to 80% to capture sensitivity to rate changes.
Rates near 4% mean “the capacity for bonds to play that defensive role in a recession is significantly stronger than it was before,” he said in an interview.
Anna Shelley, chief investment officer at AMP Ltd. in Melbourne, echoes the view.
Bonds are “back to having that ability to provide protection, particularly if we do get a much harder recession than is currently priced into market,” said Shelley, whose firm oversees A$105 billion in retirement assets. There’s “a chance that either inflation is stickier or harder to bring back into that targeted band that central banks would like to see,” she said.
AMP has reduced its underweight in bonds to a neutral position, and Shelley predicts a mild downturn in the US.
Too Early
For others like Colonial First State and HESTA, the risks of getting too early into the recession trade is too big. Superannuation funds in Australia nudged up exposure to fixed income by just a percentage point to 19% last year, but they trail peers from Japan to the UK where bonds make up more than 50% of portfolios, data compiled by Bloomberg show.
“Inflationary pressures are likely to remain more elevated than markets are currently discounting,” said Jonathan Armitage, chief investment officer at Colonial First State, which manages the equivalent of $96 billion. “We’ve got a little bit of time before those opportunities really become very, very compelling.”
“We are carrying higher cash levels that we have done for a while,” he said. “We believe that we are going to be presented with some opportunities over the next six-to-12 months to deploy that capital at very attractive prices.”
Recent economic data lend support to Armitage’s view.
While the Reserve Bank of Australia has said inflation may have peaked, that’s not the case in the US where the Fed’s favored inflation gauge unexpectedly accelerated in January. Prices have also jumped more than economists forecast in Spain and Switzerland, heaping pressure on policymakers to raise rates even more aggressively to tame runaway prices.
“It might still be a number of months, or even six or nine months away from high cash rates making a difference here,” said Jeff Brunton, head of portfolio management at HESTA, which manages the equivalent of about $46 billion. The pension fund is keeping “higher levels of cash,” as it waits for an opportunity to expand exposure into corporate debt if a recession occurs, he said.
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Deep Inversion
Still, the deepest US bond yield inversion since 1981 is indicating the Fed will end up cutting rates after driving the world’s biggest economy into a recession. It’s just that taking the bet early may incur steep losses.
Aware Super has pared back its underweight bond position as the “entry point into fixed income assets looks more attractive,” said Michael Clavin, head of fixed-income at the fund. And while calls for rate cuts are overly optimistic, bonds have a “role that they could play as a ballast to equity markets during any market downturns,” he said.
That would also bring back the classic investment 60/40 portfolios divided between stocks and bonds. In the US, that strategy lost almost 17% last year, the steepest decline since 2008, according to a Bloomberg measure.
The repricing of bonds may “still have further to go,” even though government debt is now more attractive, Raphael Arndt, chief executive at Australia’s A$243.5 billion ($161 billion) sovereign wealth fund, said in a briefing last month. But “they certainly would be defensive in a normal business cycle recession,” he said.
(Adds tout in 17th paragraph. An earlier version corrected AMP’s assets under management)
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