While local investors often struggle with the decision to invest locally or head offshore when it comes to investing in bonds, fixed income experts typically recommend a combination of both, and for diametrically different reasons.
The main attraction investors have with the global bond market – which is worth around A$230 trillion – is that it's infinitely larger and more liquid, with a wider variety of instruments and exposures.
However, that doesn’t mean local bonds don’t or shouldn’t have a place in your portfolio.
While the infinitely smaller Australian fixed income market tends to have the same local exposures, the benefits of onshore bonds comes back to their underlying value.
The local bond market is barely worth 2% of the overall global market; however, it accounts for 10% of the world’s AAA-rated bond issuances, which helps to explain why it continues to attract foreign investors.
With that in mind, Azzet asked Clive Maguchu, senior strategist with State Street Investment Management, whether investing in global bonds was really worth extra work plus the potential currency and interest rate risk associated with it?
Currency and interest rate risk
For starters, when it comes to interest rate risk, Maguchu reminds local investors that they’re typically longer duration and hence have greater sensitivity to interest rate changes versus investing locally.
Similarly, while local bonds typically have a high credit quality with government and bank bonds being AAA and AA rated, Maguchu also reminds investors that’s not necessarily the case looking offshore, where issuers have a wider variety of credit ratings.
Currency and interest rates aside, global bonds expose local investors to all the different economic cycles playing out within different markets offshore.
Given that currency can have a huge impact on fixed income returns, most institutional investors tend to hedge out their international fixed income exposures.
“Things might be going great in terms of the local rates and inflation outlook, but that might not be the case when you’re investing offshore, and Japan at the moment is going through an inflation problem, where they’re looking to raise rates,” noted Maguchu.
“So you have to be aware of all these issues when you’re investing around the world.”
Mounting debt levels
Meantime, while the global market is currently being influenced by the growing U.S. debt pile, Maguchu told investors that this issue isn’t exclusive to America.
While investors are also raising concerns about the massive amount of [debt] issuance since COVID in France, the UK, and Japan, the issue is being more broadly felt across the globe.
Since the pandemic, the average debt-to-GDP ratio for most advanced countries is sitting at about 75% and above, which compares to Australia’s much more modest 30%.
“Globally, there’s been increased concern around the willingness of governments to credibly address these high levels of debt and there’s definitely been an impact on the global market, particularly this year,” said Maguchu.
Where this is most evident, adds Maguchu, is in the yield curve, which is steepening, so investors are demanding higher yields for longer-term bonds as compensation for the perceived increase in risk from those higher debt levels.
Aussie market comes of age
Meantime, the Australian bond market has matured in recent years, with plenty of new issuance of greater variety that’s meeting the increasing demand for Australian-denominated issues.
This year alone, the Australian market is on track to reach around 1,000 non-Commonwealth new issues, worth around $350 billion of local issuances.
“On the demand side, growth has been driven by the range of investors looking to local fixed income, while the banks are accumulating more liquid assets due to increased regulatory requirements,” said Maguchu.
What’s also driving the demand side are super funds that are starting to manage the maturing composition of their portfolios by dialling down their risk exposure, while foreign investors are increasingly attracted to the high quality of the Australian market and higher yields on offer locally.
Meanwhile, when it comes to areas of future growth, on the supply side, Maguchu believes there’s more room for improvement in the number and amount of non-bank corporate issuers.
Greater scope to come
Maguchu also flags more scope for greater allocation to fixed income, both from institutional levels – super funds – and the retail wealth management market, which remains underinvested in fixed income.
Maguchu is also witnessing more Australian companies issuing in Australian dollars rather than heading overseas - which is no longer seen as attractive - with increased demand making it cheaper to raise debt in the local market.
When looking to stand-out domestic issuances for 2025, Maguchu touched on a few trends indicative of the growth being reflected in the broader market.
Firstly, there’s the largest ever residential mortgage-backed security (R&BS) issue by a non-bank lender, which came in a $2.5 billion and had significant foreign interest.
Secondly, he cites the notable extensions of the big bank tenor issuances, having witnessed a couple of 20-year tier-2 deals, with the banks typically only issuing at the shorter end of the curve.
“We’ve also seen increased issuance from foreign issuers, and in particular some of the Canadian issuers are becoming much more regular issuers in the Australian market,” said Maguchu.
“This helps diversify the choice for investors in the local Australian-denominated corporate bond market.”
Bond Issuance Update
- Ausgrid Finance (BBB/Baa1) has launched its 5-year and/or 10-year senior secured FXD and/or floating-rate transaction.
- BNP Paribas (A+/A1/A+) priced a $750 million Perp/NC5.5 FXD AT1 transaction with a first reset date in June 2031 (5.5-yrs) at SQ MS +304bps (7.00% coupon). The final orderbook was in excess of $3.75 billion, and IPG was SQ MS +340bps (7.375% coupon) area.
- Dexus Finance (A-/A3) is taking IOIs for a FXD-to-FRN and/or FRN 30NC5.25 and/or a FXD-to-FRN 30NC8.25 subordinated securities transaction.
- Natwest Markets PLC (A/A1/AA-) is taking IOIs for a 3.5-year senior unsecured FXD and FRN opco transaction. IPG has been set at 3mBBSW / SQ ASW +103bps area (5.025% indicative coupon).
- Suncorp Bank (Norifna Limited) (AA-/Aa2/AA-) priced a $1.5 billion senior unsecured FXD and FRN transaction at 3mBBSW / SQ ASW +80bps (4.70% coupon). The final orderbook was in excess of $2.31 billion, and IPG was 3mBBSW / SQ ASW +85bps area.
- Westpac Bank (AA-/Aa2/AA-) priced a $1.6 billion 1-year short senior unsecured FRN at 3mBBSW +36bps. The final orderbook was in excess of $1.6 billion, and IPG was 3mBBSW +36bps.
