It’s time for income investors to reconsider long-unloved fixed income market as yields on investment-grade bonds surge to multi-year highs, according to analysts from Morningstar and AMP Capital.

After years of treading water near zero, government bonds are offering up yields comparable to sections of the equity market for far less risk. Yields on 10-year Australian government bonds, often used as the “risk-free rate”, are north of 3% for the first time since 2014. US 10 Year Treasury Notes traded at yields of 2.8% on Thursday.

“It’s the most attractive it’s been in five or six years,” says Brad Bugg, head of multi-asset strategies at Morningstar Investment Management Australia.

“For those who had money in cash as opposed to bonds, now is a great time to get that extra pickup. For a retired investor with a lot of money in cash, this is a material increase in income.”

The return of income marks a fundamental change for bond investors accustomed to years of capital gains. Falling interest rates through the Global Financial Crisis and the pandemic buoyed bond prices and squeezed yields to near zero. That trend shifted this year as central banks from the US to New Zealand raised rates to curb inflation and warned more was to come. Investors dumped bonds in response, leaving the US$88 trillion global government bond market nursing record losses last quarter.

The Bloomberg Global Aggregate Index, which tracks investment-grade credit across 24 countries, is down 8.9% this year on a total return basis.

Plummeting bond prices bring the silver lining of rising yields, which move in an inverse fashion. Put differently, a bond’s fixed stream of coupon payments is more valuable the cheaper it is to buy, and vice versa.

“It certainly makes the bond market more attractive for investors and the 3% on the ten-year Australian government bond is getting closer to a reasonable yield, says Shane Oliver, chief economist at AMP Capital.

Rising yields have slashed the quantity of negative yielding bonds, falling from US$18 trillion in December 2020 to just US$2 trillion in March.

BetaShares Investment Grade Bond ETF (ASX: CRED) offers a running yield of 3.47% as of Friday, up from 2.9% last September, according to Morningstar data.

For those investors nursing double-digit capital losses in their bond portfolios, Morningstar’s Bugg says the worst thing they can do is sell. Investors who hold should recoup losses over the next few years as fixed-interest funds recycle maturing bonds into newer higher-yielding ones.

“The numbers you might see on a quarterly statement are daunting,” he says. “You won’t lock those in unless you sell that investment.”

Rising yields are also helping improve the case for bonds as diversifiers, adds Bugg.

Bond prices typically rise when equities fall as investors pivot to the safety of government debt amid stock market turmoil. However, with bonds so expensive until recently, there was less room to rise, undermining their value as a diversifier, says Bugg. Today’s higher yields and lower prices could give investors more appreciation in their bond portfolios during future equity downturns.

Getting the timing right

For investors looking to enter fixed interest markets, Mihkel Kase, portfolio manager at the bronze-rated Schroders Absolute Return Income Fund, cautions that this year’s selloff may not be over yet.

While there’s broad agreement across markets that developed-world interest rates are on the rise, the pace and extent are still unclear, he says. If central banks surprise by hiking faster and further than markets expect, selling could return to bond markets.

“Are we done yet with the selloff in bonds or are we expecting to see more?” he asks.

“With valuations back at neutral, it makes sense to start adding some duration to portfolios. But I’m not sure it’s the right time to go boots and all.”

Bond funds Morningstar likes

Bond investing remains a corner of the market where Morningstar believes active managers can outperform. Silver or Gold rated funds include the Janus Henderson Australian Fixed Interest fund and the BetaShares Western Asset Australian Bond ETF. Medallist ratings means analysts have a high conviction the funds will outperform peers and benchmarks.