Cash returns are set to gain on bond returns, as the yields in sovereign bonds are likely to move closer to historical levels.
Bond yields have been extremely low, which has given a boost to their returns, but the end to this trend is in sight.
"If you look at historical returns, the excess returns of bonds are well above what has been earned from cash and that is driven by very low yields that you have seen from sovereign portfolios, which generate those excess returns and we are very much at the peak of that cycle," MLC head of debt asset research Stuart Piper said at the NAB Private Wealth conference in Sydney yesterday.
"The next part of the cycle probably sees cash perform much better, relative to bonds and potentially cash outperforming bonds."
Over the twelve months to 31 January 2012, the UBS Australian bond fund, which is benchmarked against the UBS Composite Bond fund has returned 10.5 per cent.
The UBS Cash Fund, which uses the UBS bank bill index as benchmark, on the other hand returned 4.8 per cent over the same period.
A new report by Towers Watson - which announced the firm's downgrade of intermediate global developed market government and inflation-linked bonds to 'highly unattractive' - agrees with Piper's outlook.
"Our base case is for a somewhat faster normalisation of yields than what is priced into the market and as such we expect Australian bonds to underperform cash over a medium-term horizon," Towers Watson Australia head of asset class research Jeff Chee said in the report.
Chee said that investors should keep this in mind when adjusting their investments.
"If investors have a diversified portfolio and a cash or real return type benchmark, they should typically reduce duration risk by, for example, selling some intermediate bonds to buy cash and high-quality credit to maintain portfolio risk," he said.
"We believe that this is particularly the case for "stable" and "conservative" superannuation fund investment options which typically have a high allocation to bonds and where capital preservation is of paramount importance.
"We would also recommend that investors have a bias towards Australian bonds and away from overseas bonds in any allocations to sovereign bonds they do have."
Despite the better outlook for cash, Piper argued that most investors still hold too little fixed income assets compared to cash.
"I was dismayed, when I heard that the allocation to fixed income last year was about 9 per cent, because fixed income has performed much, much better than some sectors, multiples of what cash has achieved," he said.
NAB Private Wealth and JBWere chief investment officer Giselle Roux agreed: "The lack of participation of investors in the fixed income markets is a real problem."
She argued that investors should be much more diversified than they currently are.
"In our opinion, you should be across all asset classes available," she said.
"If you have one asset class in your portfolio that is not performing that is not necessarily a problem, because it tells you you are not taking just one kind of risk."
