The recent collapse in share markets has pushed superannuation returns lower in the past few months. However, things could have been a lot worse but for a little-mentioned parallel phenomenon: Falling bond rates, which have saved the day for super fund members.
Shares have tanked over a range of concerns including the trade war between China and the US, weaker US economic figures, and fears of a China meltdown. Major market indicators are down over the past six months by 13.7 per cent in the US and 11.1 per cent in Australia.
Those falls have pushed superannuation returns into negative territory in recent months and, as details arrive in the coming days, some members will read their fund lost money throughout the calendar year of 2018.
Until late last year, the smart money held that interest rates were on the way up, with the US ending quantitive easing and stronger employment figures pushing authorities to raise the cost of money.
The US Federal Reserve jacked the cash rate up eight times since 2016 to current levels of 2.5 per cent, and markets were predicting another three rises this year.
Bond traders went bearish
But sentiment changed dramatically late last year, and traders got bearish. The result was they started to predict falls in long-term rates and sold bonds. As a result, the US 10-year bond rate peaked in November at 3.25 per cent.
Australian bond rates also peaked, but somewhat earlier, at a mid-year high of 2.9 per cent. Both rates then fell away, with the US down to 2.5 per cent, and the Australian 10-year bond rate bottoming at 2.17 per cent last week.
Moves of less than a percentage point in the bond rate might not sound like much, but they are actually far more significant than the hundreds of points that have been wiped off share indexes.
“Those were dramatic moves,” JB Were fixed income expert Laurie Conheady said.
So dramatic, in fact, that the US bond rate is down 23.1 per cent and its Australian counterpart is off 21.1 per cent from last year’s highs.
The shifts signal that bond traders have dropped the idea of imminent rate rises.
“A major bank pushed back an expected Australian interest rate rise to 2020 and there has been some talk of rate cuts,” Mr Conheady said.
While the falls in rates might look like a weaker market, it is actually good news for those already owning bonds. That’s because when interest rates fall, the price paid for bonds increases.
It works like this: A $100 bond paying 10 per cent interest pays $10 a year to an investor. But if the interest rate falls to 5 per cent then a new bond only pays $5. The original bond is now worth $200 because that’s what you have to pay to earn $10 in interest by buying new bonds.
So while super funds’ share holdings have declined in value, their bond holdings have gone up by about 20 per cent as a result of interest rate falls. That’s good, but not enough to make up for weaker share markets.
Bonds stem share losses
Stocks might account for 50 per cent or so of a typical balanced fund’s assets while bonds average about 15.5 per cent, Chant West researcher Mano Mohankumar said.
So while bond profits are not as great as share market losses, they have helped stem the red ink on shares.
Retail super funds tend to have a higher percentage of assets in equities than to industry funds. But they also have more in bonds, which account for 20 per cent of their portfolios and are considered defensive assets.
Industry funds, on the other hand, have around 12 per cent of their investments in bonds, with alternative assets like infrastructure making up a significant part of their defensive allocation.
So while retail funds have a higher exposure to shares, their higher exposure to bonds should help balance that by delivering bond market profits.
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