The $60 billion pipeline of issuance in the Australian Federal Government bond market poses significant risks for super funds constructing portfolios around the UBS Australia Composite Bond Index, fixed income managers have warned.

The $52 billion domestic government bond market will more than double next year, with the Australian Office of Financial Management (AOFM) set to issue $60 billion in treasury bonds, and potentially longer-dated and inflation-linked bonds.

Mathew McCrum, director investments at boutique fixed income specialist Omega Global Investors, said while issuance in the corporate bond market has been short-dated since 1996, that trend is about to be reversed.

“That will do two things; it will push up the duration of the index, and it will decrease the amount of corporates in the index, and I would argue that’s at just the wrong time for investors,” he said.

“With governments borrowing a lot of money that’s likely to put upward pressure on interest rates, particularly at the long end of the yield curve, and with credit spreads at all time highs, it’s a great time to get into credit organisations that can pay back debt and are financially healthy. It’s not a great time for long-dated bonds with pressure on interest rates and the amount of borrowing that’s about to occur.”

Rather than simply adopting the benchmark, McCrum said super funds should be building their defensive portfolios around their needs, aiming for low volatility and adopting a bias to organisations that are financially healthy.

In mid-May, the AOFM announced that consideration would be given to issuing longer-dated treasury bonds and resuming issuance of treasury indexed bonds.

“The issuance of such bonds would assist portfolio management by widening the range of available debt instruments, diversifying risk and potentially tapping additional sources of investor demand,” the AOFM said in a statement.

Mick O’Brien, chief executive officer of Invesco, said the issuance of longer dated securities would require more active interest rate management by super funds.

“Obviously the longer dated the securities, the more attention that needs to be paid to interest rate management,” he said.

“What we might see is much more active interest rate management strategies being applied to these fixed income portfolios. A 10 basis point movement on a 20-year security is going to have a significant impact on price.”

He questioned whether there was sufficient demand for index-linked bonds given the small amount of defined benefit liabilities in the Australian market.

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