Since the pandemic shock of early last year, investors have more recently focused on the after-effects. Record government stimulus, monetary policy easing and the roll-out of vaccination programs are now intersecting with the gradual lifting of lockdown restrictions.
These forces are feeding rising inflation expectations, expressed through a sharp increase in nominal bond yields. Last November, the Australian 10-year nominal government bond yield moved through 0.80%. Since then, it has taken just four short months to pierce a high of 1.90%, settling at around 1.70% more recently.
This is important because the government bond yield, or risk-free-rate as it’s sometimes known, is a reference for the theoretical valuation of all manner of financial assets but especially ‘bond proxies’ like AREITs.
The theory is that as the risk-free rate rises, returns from assets like AREITs falls. That’s certainly been the case in Australia of late. With investors moving out of cash and listed bond proxies into more cyclical opportunities, AREITs underperformed the broader market by about 4% over the initial period of calendar year 2021 (they have since recovered some ground returning 6.30% in March).
Oddly, this hasn’t been the case in the United States, which experienced a similar rise in the risk-free rate. As the chart below shows, although nominal bond yields in the US increased by a comparable 0.70% so far this year, REITs outperformed by almost 5% in local currency terms.