Geopolitical shock, AI disruption and a case for Australian bonds

Two major shocks hit markets this quarter, one was geopolitical; the other was technological. Together, they have created one of the most difficult environments for traditional portfolios in recent memory.

Richard Quin, chief investment officer at Bentham Asset Management, one of Australia’s leading fixed income and credit managers, has been navigating both.

“The closure of the Strait of Hormuz has been the dominant market event of the quarter,” Quin says. “Bonds sold off, credit spreads widened and equities declined meaningfully. The standout was commodities, which rallied around 35 per cent.”

The supply-side shock from the Strait of Hormuz closure has fed directly into inflation and repriced assets broadly. For advisers managing traditional balanced portfolios, the environment has been genuinely testing.

The AI disruption that got lost in the noise

The Gulf crisis was not the only significant story. Artificial intelligence (AI) disruption to software businesses was running as a parallel shock through the quarter, one that Quin says would have dominated headlines in any other environment.

The rapid improvement in AI models has fundamentally changed the cost structure of software businesses, undermining the economics that underpinned their valuations. Public credit markets saw spreads in software names widen around 375 basis points. The impact in private credit was more severe.

“The largest impact was in private credit, where funds with high software exposure, around 30 per cent of many portfolios, saw six times the average redemption rate and were forced to gate redemptions at 5 per cent,” Quin says.

For advisers with client exposure to private credit funds carrying significant software allocations, that figure is worth understanding. Redemption gating at 5 per cent is a real liquidity constraint. It changes the practical reality of those holdings regardless of how the underlying assets are marked.

Playing defence without sitting on the sidelines

Bentham’s response has been deliberate and conservative. Bentham has reduced high-yield exposure to around 4 per cent, the lowest the firm has ever held. In its place, the allocation to supranational agencies and semi-government securities has increased, offering strong credit quality alongside what Quin describes as still attractive margins.

Loan margins have also become more appealing for income, though Quin stops short of enthusiasm about the broader credit market. “Broadly, credit markets remain expensive,” he says.

The duration positioning tells its own story. Bentham reduced duration in March following the initial shock, then added some back in early April. The fund now sits at around five years duration, a considered middle ground that reflects both the near-term inflation risk and the longer-term opportunity Quin sees emerging.

The case for Australian bonds right now

The more forward-looking part of Quin’s commentary is the case for duration at current yields. It rests on a historical pattern that has played out consistently through previous energy shocks.

“Historically, energy shocks drive inflation higher before energy prices come down, and when they do, that provides a meaningful tailwind to bonds. At around 5 per cent, the Australian bond market is one of the most attractive in the world right now, and we believe investors will be well compensated over the next 12 months.”

That is a meaningful statement from a chief investment officer who has just reduced high-yield exposure to record lows. Bentham pairs its conservatism in credit with genuine conviction in duration, and the logic connecting the two is worth explaining to clients who may be instinctively cautious about bonds in an inflationary environment.

Where to focus before the new financial year

The quarter has exposed two specific vulnerabilities in many client portfolios. The first is concentration in private credit funds with high software exposure. The second is insufficient duration to benefit when the energy shock eventually unwinds.

Neither of these requires dramatic action, but both warrant a conversation. The private credit question is about liquidity and what redemption constraints mean in practice for clients who may need access to capital. The duration question is simpler: are client portfolios set up to benefit when energy prices eventually fall and bonds rally?

Advisers who know where their clients stand on both fronts will be ready to act when conditions shift. With the new financial year approaching and fixed income and credit allocations due for review, now is a good time to have both conversations.