Feb. 11 (Bloomberg) -- Goldman Sachs Asset Management is avoiding Australia’s sovereign bonds and favoring floating-rate debt as it predicts 10-year yields may rise as much as one percentage point this year.
That would exceed 2013’s increase, which drove the weakest returns on government bonds in four years. The fund manager also likes infrastructure debt and mortgage-backed securities, said Philip Moffitt, head of fixed income for Asia-Pacific at Goldman Sachs AM in a Feb. 6 interview in Sydney. Lower-rated debt sold outside of Australia is also worth considering for local investors due to higher yields and increased diversity, he said.
Australia’s 10-year yield climbed to a two-week high of 4.18 percent today. The Reserve Bank of Australia this month raised its economic growth and inflation forecasts, reflecting a weaker currency, and signaled an end to its rate-cutting cycle. Yields on U.S. Treasuries of similar maturity will advance to 4 percent by Dec. 31, Moffitt said. The Goldman Sachs Core Plus fund was the best performer among peers in the final quarter of 2013, according to Morningstar Australia Pty.
“It’s really difficult to see investors with high exposure to bonds making strong returns this year,” Moffitt said in Sydney. “In portfolios where we have flexibility, we’d be in floaters to protect against rising yields and we also like infrastructure and mortgage-backed debt. We’re staying away from government bonds and high-quality credit.”
The advance in Australia’s 10-year yield this year will range from 75 to 100 basis points, Moffitt forecast.
The rate was at 4.17 percent as of 12:11 p.m. in Sydney, having touched the highest level since Jan. 23 earlier today. It ended last year at 4.24 percent and analysts predict a rise to 4.57 percent by the end of 2014. That would follow a 96 basis point gain in 2013 that came as investors reassessed the path of monetary policy in Australia and amid a tapering of Federal Reserve stimulus that spurred a global selloff in bonds. Treasury 10-year yields rose 130 basis points last year.
Australian sovereign bonds returned 0.1 percent in 2013, the least since 2009, and an index of securities issued by state governments climbed 2.5 percent, according to Bank of America Merrill Lynch indexes. A gauge of the broad market climbed 1.9 percent with BBB rated bonds leading with gains of 6.8 percent, double the return on AA rated paper and more than five times the advance for top-rated notes, the data show.
“You’re probably better off in cash than holding a portfolio of state bonds and other high-quality credit,” Moffitt said.
The Australian dollar’s 12 percent drop over the past year will help boost gross domestic product by 2.75 percent in the year to June, compared with November’s estimates of 2.5 percent growth, the RBA said Feb. 7. The economy will expand between 2.25 percent to 3.25 percent through December, it said.
The Aussie, the world’s fifth most-traded currency, climbed as much as 0.7 percent today to 90.15 U.S. cents, the strongest in four weeks.
The RBA increased forecasts for growth and inflation after the central bank signaled an end to a two-year easing cycle following a Feb. 4 meeting. The RBA will add 14 basis points to its record-low cash rate of 2.5 percent over 12 months, according to a Credit Suisse Group AG index based on swaps. Bets rose as high as 18 basis points on Feb. 7, the most this year.
Reports today showed that Australian house prices rose 9.3 percent in the fourth quarter, while home-loan approvals unexpectedly dropped 1.9 percent. A National Australia Bank Ltd. gauge showed business confidence in January rose for the first time in four months.
Goldman Sachs AM is favoring floating-rate notes where coupons paid are determined by adding an agreed margin to a moving benchmark interest rate such as the Australian bank-bill swap rate, insulating investors from moves in underlying yields.
About half the A$335 billion ($302 billion) of unsecuritized Australian-dollar-denominated notes from non-government-backed issuers that are currently outstanding have a floating-rate coupon, according to data compiled by Bloomberg, while most securitized transactions including mortgage-backed notes are also linked to moving benchmarks.
The federal government, which carries an unblemished AAA credit score from the three major credit ranking companies, is the largest issuer in the Australian bond market, along with the state governments and the four largest banks, which are also highly rated.
Owners of Australian infrastructure and transport hubs have also borrowed in the domestic market, appealing to investors that want to take on greater credit risk. Issuers last year with ratings at the lower end of the investment-grade spectrum included rail-freight company Aurizon Holdings Ltd., electricity distributor Powercor Australia LLC and the Port of Brisbane.
Australia’s bond market is predominantly investment grade, meaning that money managers wanting to buy junk-rated debt need to look elsewhere, in particular the U.S..
The Bank of America Merrill Lynch U.S. High Yield Index offered an average yield to maturity of 6.35 percent yesterday, 416 basis points more than Treasuries. The U.S. Corporate Index offered a spread of 128 basis points, while a comparable Australian gauge yielded 124 basis points more than local sovereign notes.
“The argument for owning foreign credit, hedging it back and synthetically creating Australian duration risk with foreign credit spread risk is very persuasive,” Moffitt said. “You get better liquidity and better diversification in your portfolio.”
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