The government and government bond market rarely excites me. I tended to put it in the “no risk, no return” category. In fact, when we had a zero interest rate policy, it would be more accurate to say that I viewed it as “high risk, no reward.” The risk was not credit risk but duration risk. Duration risk is perhaps considered more acceptable; However, some investors who bought long-term fixed-rate government and government bonds are now sitting on large capital losses, suffering the kind of declines you wouldn’t expect to see in the defensive part of your portfolio.

Looking back, there were a few periods where I should have been more excited about this part of the market. Just before the GFC, when I worked in the UK, government bond yields were around 5%. If only I had had the foresight to buy government bonds at that time. Yields have consistently fallen, meaning the value of capital has consistently increased, from April 2007 to July 2020, when yields reached almost zero.

Then, shortly after moving to Australia in 2013, the 10-year yield was above 4% and fell below 1% in 2020. Once again, this decline in yields allowed government bonds to to provide outsized returns for the risk taken.

We now know and can clearly see from the charts above that yields have risen sharply again. Australian yields are now once again higher than levels I should have paid more attention to in the past! I don’t see us returning to a zero-rate world. However, I see yields falling as the RBA begins to enter its easing cycle. Once again, falling yields should support the strong performance of these bonds.

Having learned from the past, I currently see two distinct ways to take advantage of this opportunity in government and state-to-government bonds. One will suit income seekers and the other will appeal to investors looking to achieve capital growth. Let’s discuss each person’s case.

Income Seeking Opportunity

There are a number of higher coupon bonds in this space. These bonds allow investors to guarantee a current return* of more than 5% over the long term. This may not seem much better than term deposit returns at the moment, but over the cycle this is a very attractive income to secure on such a quality asset.

Note that the Queensland Treasury Corporation (QTC) deadline is 2033 and the South Australian Financing Authority (SAFA) deadline is 2038 – so we’re talking about securing longer-term revenue here. QTC is a clear winner in terms of revenue generation, with a running yield of 5.88%, but it also trades at a much higher price. A price of 110.5 may seem like a significant premium to earn this income, but this bond was trading in the low 160s when yields hit their lowest level in 2020!

Capital Growth Opportunity

Many bonds issued during the Covid years have very low coupons. The capital value of these bonds has been severely hit by rising yields, but this creates an opportunity for investors looking for heavily discounted assets. Often, bonds trading at such discounts experience some level of financial distress, but in this case we are talking about the highest quality, AAA-rated assets. For patient investors who don’t rely heavily on income, these stocks look very attractive. Yes, the deadlines are a long way off but, again, when the RBA starts to taper, I wouldn’t be surprised to see a significant recovery in some of these capital values. It is not necessarily a question of waiting for the deadline to obtain par (100).

The fact that you can buy an Australian Commonwealth Government bond for almost 50 cents on the dollar is pretty extraordinary. At the risk of stating the obvious: a nominal $100,000 parcel of this bond would cost just over $52,000.

These are just four of the bonds offered in this space and there are many more to choose from. However, these clearly show the opportunities available, whether you are an investor looking for income or an investor looking to achieve capital growth. Although past performance is not an indicator of future performance, the risk/reward ratio of these investments is attractive to an allocation of investors who accept a lower interest rate or interest rate that will play out over time. time.

Having missed these opportunities in the past, this time around I hope investors will be placed in positions that appear to offer very attractive returns for the risk.

*The current yield is the annual return you will receive on a bond. It does not take into account any movement of capital.