Bond ETFs: Higher rates down under


by Dr. Marvin Appel, editor Systems & Forecasts

Negative real interest rates pose particular hardship on retirees who are depending on their investments to generate income and who cannot afford to take too much risk.

Moreover, investing in bonds during periods when real yields have been negative has historically been an unfavorable proposition. One solution is to look for areas of the world where interest rates are more attractive. The land down under is such as place.

Both Australia and New Zealand have histories of high real interest rates,. This benefits not only bond investors, but percolates into these countries’ stock markets, which pay dividends well above worldwide averages.

The Australian 10-year government bond yield is 1.6% above the rate of inflation. This is low by Australian standards (and would be about historically typical in the U.S.), but for now is the best game in town.

As a parenthetical irony, even though Japan has extremely low nominal interest rates, because they are in a chronic state of deflation or flat prices, their real interest rates are relatively high.

It is to avoid getting stuck in this situation that the Federal Reserve has been so aggressive in trying to stoke infl ation.

There are two bond ETFs that offer exposure to Australian bonds: Pimco Australia Bond Index Fund (AUD) and Wisdom Tree Australia and New Zealand Debt Fund (AUNZ).

Both hold bonds with an average maturity of approximately four years and high credit quality, and both have SEC yields of just over 3%. Neither trades very heavily, so they are suitable for individual investors but potentially less so for money managers.

The main risk here is currency risk. If you purchase one of these ETFs for the yield, the value of that interest income will fl ctuate along with the foreign currency, as will the principal of your investment.

A long-term bet on Australian bonds is a long-term bet on strong demand for commodities, which has tended to drive up the value of the Australian dollar. I believe this is a bet worth making with at least some of your bond capital. This is a diversifier.

My favorite bond strategy in this environment is corporate high yield bond fund trading. However, these ETFs could be good for up to 10% of your bond portfolio. Future results are not guaranteed, of course.

When interest rates rise, the price of these ETFs will fall. However, their maturities are sufficiently short that interest-related losses should be moderate, and temporary. In fact, a rise in interest rates will be of long-term benefit to investors in these ETFs.