Bond Market Offers Rare High Yields on Safe Assets

The Israeli bond market is currently presenting unique opportunities for investors seeking high, stable returns, according to Avihod Baron, Deputy CEO and Chief Investment Officer at Meitav Dash Provident Funds. Despite Bank of Israel rate cuts, longer-term bond yields have risen, making them attractive. Baron notes that while U.S. 10-year Treasury yields are currently higher than Israeli equivalents, the comparison is misleading when considering dollar-denominated Israeli government bonds, which still offer a risk premium.

Baron suggests focusing on the mid-section of the Israeli yield curve, specifically bonds with maturities of 2 to 4 years, as the most compelling area for investment. He also favors increasing exposure to government bonds over corporate bonds, warning that current spreads in the corporate sector do not adequately compensate for the associated risks. However, he is gradually building exposure to long-term government bonds and sees potential in U.S. debt for those willing to accept currency risk.

He explains that the perceived gap between Israeli and U.S. bond yields is largely due to differing monetary policies, with the U.S. Federal Reserve raising rates while the Bank of Israel has been cutting them. Baron also points out that global market volatility, exemplified by France's widening bond spread against Germany, highlights the importance of fiscal stability, a risk Israel must manage post-election.

Regarding currency hedging, Baron notes that the current cost makes it less attractive for shekel investors to buy U.S. Treasuries. He advises a balanced approach to currency exposure, with a slight overweight towards inflation-linked bonds due to potential unpriced risks like fuel subsidies ending and global commodity price increases. He also expresses caution about certain segments of the corporate bond market, particularly those with weak fundamentals or high refinancing risks, preferring bonds from banks, insurance companies, and stable real estate firms.

Baron believes that the market has not fully priced in potential interest rate cuts by the Bank of Israel, especially if inflation continues to moderate and election results are viewed positively. He sees an asymmetric bet in the 2-5 year maturity range, offering significant upside with limited downside if rates are cut. For a 12-18 month portfolio, he suggests a mix of Israeli government bonds, U.S. Treasuries, and corporate bonds, with a preference for longer maturities in the government sector due to the absence of credit risk and attractive absolute yields.