DIY Investor Magazine
| August 2017
36
AN INTRODUCTION TO GOVERNMENT
BOND ETFS
Dominique Riedl
CEO, justETF
What are government bonds and why should they be in
every investor’s portfolio?
Government bonds are debt – IOUs -issued by
sovereign governments such as the UK, the US,
and Japan; where there are governments, there are
usually government bonds, because governments love
spending money, especially money they haven’t got - a
nuclear power station here, a social programme there.
Essentially governments can make themselves
popular by popping life’s little extras on credit now
and leaving others to worry about it in 10, 20 or 50
years time when the loan comes due.
Those loans often come in the shape of
government bonds which promise to pay you back
interest every year (the coupon) and the full amount
borrowed at maturity.
That makes sense for government and investors
alike; during a recession, demand from private
individuals and corporations drops, as does
government income from tax, but the government
can plug the gap and keep people in work by
issuing bonds that raise funds to, for example,
renew the national infrastructure, or keep paying for
the NHS.
Investors are happy to lend to stable governments
like the UK because they have faith that the country
will still be standing and paying them a reliable
source of income many years into the future.
The global bond market is huge – far bigger than
equities - and government bonds are the largest,
most important and liquid part. Unsurprisingly the
world’s superpower and biggest debtor nation, the
US, is the major issuer of government bonds and
although no asset can ever be truly risk free (see
below), the strength and stability of the US is such
that its bonds are often thought of as the safest
asset available.
A testament to its economic strength aging
population and 25-year struggle with low growth
Japan is the second largest government bond
issuer followed by China and then a clutch of large
European nations - UK, Italy, France and Germany
- who were forced to ramp up their debt levels to
maintain growth in the aftermath of the financial
crisis.
WHAT ARE THE BENEFITS OF GOVERNMENT
BONDS?
Investors value high-grade government bonds
because they are the best available complement to
equities; they tend to be more stable than equities
and often perform better during recessions which
can reduce portfolio losses in a crisis and prevent
investors from panicking when equities plunge.
Having a government bonds in your portfolio is
the essence of diversification; they can deliver a
reliable source of income when bills need to be
paid and equities are down, and they can also be
used to buy more equities when prices are cheap.
The reason that high-grade government bonds
bear up well in turbulent times is because they are
backed by strong nations; the US and UK have
never defaulted on their debts. Companies can
go bust but a developed nation that has survived
World War, rampant inflation and the financial crisis
is a good bet. Investors believe these countries will
manage their finances prudently in the future and
so flock to them as safe havens when the global
economy is threatened.
Developed nations are likely to keep paying income
to investors for the foreseeable future and if interest
rates fall then you can even make a capital gain as
bond prices rise.
GOVERNMENTS LOVE SPENDING MONEY, ESPECIALLY
MONEY THEY HAVEN’T GOT
