Investing in a DirectBond portfolio through FIIG means you will have control over what you invest in, when you buy and sell, access to daily pricing and market leading reporting. This note suggests a beginner’s portfolio that can be scaled up or down and meets my suggested 70% investment grade, 30% high yield allocation
Those new to investing in bonds may find the range of bonds and the risks and returns on offer overwhelming. Here I suggest a beginner’s bond portfolio for $500,000 that can be scaled up or down if you want to invest more or less. The portfolio meets my suggested target 70% investment grade and 30% high yield to boost overall returns.
Here are a few key things to consider:
- What is your goal for the portfolio?
- Capital preservation
- Good relative return given the risk involved
- Is it primarily defensive or do you include an allocation to high yield for growth?
- What is your view on interest rates?
- If you think rates will be low for longer, you would have a high proportion of fixed rate bonds
- If you believe interest rates are going to rise, you would maintain a higher percentage of floating rate bonds
- Do you want to incorporate some inflation protection?
- Check your current portfolio and the allocations to various sectors. Many investors are overweight banks and financial institutions when they take deposits, shares and hybrid securities into account. If that also applies to you, have a preference for other sectors or at least make sure the financial institution bonds you invest in, are names that you don’t already have in your portfolio.
- Are there any sectors or companies that you wouldn’t invest in due to ethical considerations? We find coal related industries and pay day lenders are sectors some prefer to avoid.
A beginner’s bond portfolio
- All Australian dollar denominated securities
- Investment grade 71%, high yield 29%
- Fixed 49%, Floating 29%, Inflation linked 22%
- Weighted average yield to maturity 4.80%pa
- Weighted average term to maturity 5.77 years
- Investment per high yield bond lower at $30,000 versus $50,000 for investment grade, the two inflation linked bonds had an original face value of $40,000. The face value shown in the table includes accumulated inflation since the bonds were first issued.
- The majority of the bonds listed below are available from $10,000 per bond, allowing new investors to scale up or down depending on risk appetite
- The first bond matures in 2019, there are no maturities in 2020, but then at least one bond matures every year for the next five years, building in natural liquidity
Note: Prices accurate as at 27 August 2018 but subject to change
Inflation linked bonds assume inflation is 2.5%pa - the RBA board target mid point
Green - Wholesale, Red - Retail
For those investors that want a lower risk portfolio, you could remove the high yield bonds and add more investment grade corporate bonds or even lower risk state or Commonwealth government bonds.
If you would like to achieve even higher returns, you could add more high yield bonds – remember our preference is to own many of these to help reduce the risk to your overall portfolio should anything go wrong. Their high yields on offer are to compensate for higher risk. Typically the companies or the industries they operate in are more volatile and things can change quickly.
A good example in the above portfolio is the Virgin bond. It pays a high, equity like return of 7.22%pa, but airlines are notorious for being exposed to highly volatile fuel prices. That doesn’t mean you necessarily avoid them, it’s just that you want to make sure you are being paid enough to invest.
Beginners bond portfolio cashflow
The cashflow below sets out the income you can expect to receive over the next 12 months, which is $27,225. The total shown in the table includes repayment of the Bendigo and Adelaide Bank bond of $50,000, which is assumed in January 2019 when the company can exercise its early repayment option at no penalty.
Investing in a short dated bond gives you options. For example – to invest into a higher rate market or take an opportunity with another bond without having to sell down something else or to simply use the funds to pay for a planned expense like a trip overseas or a wedding.
Notes: The floating rate bonds - Bendigo and Adelaide Bank, Challenger and Sun Group show constant interest payments but interest is adjusted quarterly and this is a guide onlyIf you are keen to talk to one of our experts and have us suggest a portfolio to meet your needs, please call 1800 01 01 81 or email firstname.lastname@example.org.
* This is an amortising bond that returns some principal over the life of the bond
# Inflation linked bonds that assume CPI is 2.5%pa -see how income rises each quarter in line with expected positive inflation
One of the many advantages of buying bonds direct through FIIG is that you will have a relationship manager looking after you, that you can call or meet with to discuss your investment options. You’ll also have access to other experts in the business from Credit Research, Investment Strategy and Education.
Is the initial capital value of the bond and the amount repaid to the bondholder on its maturity, usually $100.
Fixed rate bond
A fixed rate bond is a security that pays a fixed pre-determined distribution or coupon. The coupon of a fixed rate bond will be set at the time of issue and not change during the life of the bond. The Commonwealth Government, state governments, banks and corporates all issue fixed rate bonds in Australia.
Floating rate bond
A floating rate note (FRN) or bond is a security that pays a coupon linked to a variable benchmark.
In Australia most FRNs pay a coupon set as a margin above the bank bill swap rate (BBSW) which is the market benchmark three month interbank rate. The actual coupon for an interest period will be determined at the start of that period by applying the margin to the three month BBSW rate on the first day of the coupon period. The three month BBSW rate will rise and fall over time based on prevailing interest rates. The margin is fixed and will be set at the time of issue.
Inflation linked bond
Index-linked bonds are securities whose return includes a component that is determined by the future level of a predetermined index, for example; CPI or inflation. There are two main types of inflation linked bonds issued in Australia:
- capital indexed bonds (CIB)
- inflation indexed annuities (IIA)
CIBs pay a pre-determined coupon based on a capitalising principal amount where the capitalisation is a function of inflation. At maturity the investor receives the capitalised face value. An IIA is an annuity structure where each periodic payment includes a coupon and principal component where the principal is adjusted for inflation. The Commonwealth Government, state governments and some corporations have issued inflation linked bonds in Australia.
ILBs are also known as inflation indexed bonds or CPI bonds
Yield to maturity
The return an investor will receive if they buy a bond and hold the bond to maturity. It refers to the interest or dividends received from a security and are usually expressed annually or semi-annually as a percentage based on the investment's cost, its current market value or its face value. Bond yields may be quoted either as an absolute rate or as a margin to the interest rate swap rate for the same maturity.
It is a very useful indicator of value because it allows for direct comparison between different types of securities with various maturities and credit risk.
Note that the yield and coupon are different.