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JBWere sees diminishing returns on bonds in low interest rate environment

Friday 9th March 2012

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JBWere, the private wealth manager owned by National Australia Bank and Goldman Sachs, says it may be time to reduce holdings of bonds interest rates plumb new lows.

The bull bond market of the past three decades, where interest rates steadily declined, has left central bank rates, which anchor the yield curve, near zero percent in response to the global financial crisis and European sovereign debt woes, JBWere strategist Bernard Doyle said in a note this week. There is now a heightened risk of capital losses as yields start rising again.

“With US yields sub-2 percent and the world looking a little less unstable, the appeal of bonds in portfolios is reduced,” Doyle said. “In New Zealand, yields are higher, but here too, rewards are low verses history.”

The yield on 10-year New Zealand government bonds was recently at 4.15 percent. It reached an all-time low of 3.76 percent in December, in a year when the benchmark bond shed about 2 percentage points. The bond yield is 218 basis points more than comparable US 10-year Treasuries at 1.97 percent.

Treasuries bottomed out at 1.67 percent in late September though US rates are set to stay low for the next few years with the Federal Reserve recently reaffirming its view that it won’t move until 2014.

New Zealand wholesale interest rates have been rising in recent weeks as traders start buying into the theme that the Reserve Bank will start increasing interest rates in the next 12 months. The five-year swap rate has risen 40 basis points since the start of the year and was recently quoted at 3.65 percent.

Reserve Bank, Governor Alan Bollard yesterday warned the strength of the New Zealand dollar, which has reached post-float record highs in the past seven months, may keep the official cash rate at a record-low level for longer.

JBWere recommends its clients hold about 10 percent less in bonds than normal, replacing that allocation with cash and high-growth alternative assets, including investments in commodities, private equity and hedge funds.

The spread between bonds and cash has narrowed, especially given the competition in term deposits, while alternative assets are an “attractive avenue for seeking capital growth that is less dependent on the economic cycle,” Doyle said.

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