Thursday 05 July 2018 by Elizabeth Moran Trade opportunities

A forgotten treasure – inflation linked bonds

If you are looking for low risk, long term stability, inflation linked bonds are a good investment to anchor your portfolio. They generally finance monopoly like infrastructure assets where income is linked to inflation, with good cashflows, which is perfect for bond investors

treasure-chest

Inflation linked bonds deserve a place in every portfolio. Even though inflation is low, as it has been for some time, it is essential to protect against an outbreak in inflation.

Oil price rising – a key contributor to inflation

While there are many factors that can influence inflation, such as full employment, the exchange rate and international financial markets, rising oil prices can contribute.

Did you know the price of oil has been gradually rising since the start of the year? West Texas Intermediate (WTI) is up a significant 24% to USD74 per barrel, while Brent, another oil benchmark is up 22% to USD77.5 per barrel. The price of oil is important in an economy as it impacts costs and can push inflation higher if passed onto consumers. Think about the cost to manufacture and the cost to transport by road and air.

Rising fuel contributes to rising costs and flows through to higher prices. Higher prices contribute to inflationary pressure.


Source: Investing.com

While we don’t expect rising oil prices to lead to any break out in inflation, it’s one of the risks that could harm the purchasing power of your portfolio should it take hold.

Thus, I’ve always liked the protection offered by inflation linked bonds:

  1. They are one of the only instruments that offer a hedge against inflation. Rates of return are quoted as CPI + a fixed margin. No matter how high CPI goes, returns on the bonds will be determined by CPI rates. It’s worth noting in most issues there is usually a floor, that means deflation is limited to the issue price of the bond. While rampant inflation has been absent for many years, past break-outs where it reached double digit figures serve to remind investors, especially if you no longer have any protection via wages, that you absolutely need some inflation protection in your portfolio.
  2. There are two different types of bonds available. One that better suits those in accumulation – capital indexed bonds, and the other that suits those in drawdown – indexed annuity bonds.
    1. While income is about half or less with capital indexed bonds at the moment, CPI is contributing to capital over time, great for those building wealth within super and wanting inflation protection at the same time.
    2. Indexed annuity bonds may be better for SMSFs in drawdown, helping return capital and meet minimum withdrawal requirements as retirees age.
  3. Margins over inflation are close to deposit rates for some investment grade bonds, providing a reliable income and chance to outperform fixed rate comparables, should inflation rise.

Below is a selection of available bonds.

Company Credit rating Maturity date Coupon Bond type  Yield (CPI+) 
Australian Index Linked N/A 20-Sep-25 3.00% Capital indexed 0.31%
Ale Finance Company Pty Ltd AAA 20-Nov-23 3.40% Capital indexed
1.46%
Sydney Airport Finance N/A 20-Nov-30 3.12% Capital indexed
2.37%
Australian Gas Networks N/A
20-Aug-25 3.04% Capital indexed
1.97%
MPC Funding Ltd AA 31-Dec-25 Annuity Indexed annuity 2.18%
Australian National University N/A
7-Oct-29 Annuity
Indexed annuity
1.78%
JEM NSW Schools II Pty Ltd N/A
28-Feb-31 Annuity
Indexed annuity
2.12%
Civic Nexus Finance Pty Ltd N/A
15-Sep-32 Annuity
Indexed annuity
2.01%
RWH Finance Pty Ltd A2 30-Jun-33 Annuity
Indexed annuity
2.28%

Source: FIIG Securities
Blue = Retail, black = Wholesale investors only

Please call your local relationship manager for more information.


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