Popular bonds deliver rock-star returns

22:20, May 05 2013

Like an accountant promoted to lead singer of a famous rock band, New Zealand government bonds have become the darlings of the global investment community after delivering equity beating returns.

In the two months ending April 30, 10-year government bond has produced a 4.9 per cent total return, and yields were last trading at 3.165 per cent - a historic low.

At that level, returns are in the same ball park as equities: over the same timeframe the Standard & Poor's 500 returned 5.2 per cent, the Dow Jones 5.3 per cent and the NZX 50 Index 6.1 per cent.

For US investors, the deal is even sweeter thanks to the weakness in the greenback lifting bonds returns further to deliver a total gain of 8.5 per cent.

The main driving factor is the relatively healthy state of the New Zealand economy versus the moribund macroeconomic picture.

New Zealand's economy expanded at a 2.5 per cent pace in 2012, whereas Japanese growth was virtually flat for the year and the Euro Zone contracted by almost a percentage point.

Quantitative easing by major central banks have also added momentum, keeping interest rates in Europe, the US and Japan near zero, while in New Zealand the official cash rate is hovering at 2.5 per cent - a level that's expected to rise early next year.

"It's a very notable outperformance and reinforces what we have been saying about the attractiveness of New Zealand assets compared to the rest of the world," said Sam Tuck, a market strategist at ANZ.

Demand has also been boosted by a lack of supply, with the Debt Management Office this year choosing to sell bonds via a one-shot syndication process, rather than the weekly auction.

Christian Hawkesby, director of fixed income at Harbour Asset Management, said syndication had the counter logical effect of limiting supply by cutting the sale of small lots of paper at weekly bond tenders, but also boosting liquidity by getting a whole lot of debt away in one go.

He said it's improved investor confidence because they know they can easily sell out if they need to.

Both ANZ and Harbour expect demand to remain steady as investors chase higher yielding safe haven assets amid the current spate of macroeconomic weakness.

Hawkesby said the turning point will probably come when global activity indicators move from "soggy to show signs of a sustained recovery" particularly in US job market.

Bonds - the cliff notes

Bonds are debt securities that pay interest on a regular basis, and when the pre-set duration is finished the principal investment is returned to the investor.

Yield is a measure of the interest payment on the bond, quoted as a percentage of the value of the bond.

Bond yields move inversely to the price. So bonds that are in demand will see investors pay more and accept a lower yield, or risk premium, to hold them.

Total bond returns factor in changes in yield and capital.