Wednesday 03 June 2020 by Jonathan Sheridan image for the Wire beginners bond port Trade opportunities

Just for starters - A beginner's bond portfolio

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 our 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 we suggest a beginner’s bond portfolio for $600,000 that can be scaled up or down if you want to invest more or less. The portfolio meets our suggested target range of ~70% investment grade and ~30% high yield to boost overall returns.

Here are a few key things to consider: 

  1. What is your goal for the portfolio?
    1. Income
    2. Capital preservation
    3. Good relative return given the risk involved
    4. Is it primarily defensive or do you include an allocation to high yield to enhance return?
  2. What is your view on interest rates?
    1. If you think rates will be low for longer, you would have a high proportion of fixed rate bonds
    2. If you believe interest rates are going to rise, you would maintain a higher percentage of floating rate bonds
    3. Do you want to include some inflation protection?
  3. Check your current portfolio and the allocations to various sectors.
    1. Many investors are overweight banks and financial institutions when they take deposits, shares and hybrid securities into account. If that also applies to you, you may want to consider 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
  4. Are there any sectors or companies that you wouldn't invest in due to ethical considerations?
    1. For example, some investors have an environmental bias and will not invest in mining companies; others prefer not to invest in other lenders who specialise in sub-prime lending.  
  5. A beginner’s bond portfolio

    Key features:

    • All Australian dollar denominated securities
    • Investment grade 76%, high yield 24%
    • Fixed 41%, Floating 32%, Inflation linked 27%
    • Weighted average yield to maturity 4.46%pa
    • Weighted average term to maturity 6.23 years
    • Investment per high yield bond lower at $25,000 versus $50,000 for investment grade. The inflation linked bonds had an original face value of $50,000. The face value shown in the table includes accumulated inflation since the bonds were first issued.
    • All 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 2021, and then at least one bond matures every year for the next five years, building in natural liquidity

    table v2 for beginners port 020620
    Note: Prices accurate as at 01 June 2020 but subject to change. Inflation linked bonds assume inflation is 2.0%pa.

    For those investors that want a lower risk portfolio, you should choose the Conservative sample portfolio, which removes the high yield bonds and adds more investment grade bonds and lower risk state or Commonwealth government bonds.

    If you would like to achieve even higher returns, you could add more high yield bonds such as the High Yield sample portfolio - remember our preference is to own more of these with smaller parcel sizes 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.

    These portfolios can be viewed in more detail here.

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    Beginners bond portfolio cashflow

    The cashflow below sets out the income you can expect to receive over the next 12 months, which is $27,704* (excluding the Liberty 2018-4 D RMBS as the cashflows cannot be easily predicted).

    Graph 1 sample bonds 020620

     

    The Next DC June 2021 bond is due to mature in just over a year’s time. 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 (hoping we are able to do that again soon!).

    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 our Credit Research and Investment Strategy teams.

    If you would like to talk to one of our experts to discuss a portfolio to meet your needs, please call 1800 01 01 81 or email info@fiig.com.au.

    Glossary 

    Face value
    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)
    • indexed annuity bonds (IAB)

    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 and capital return received from a security and are usually expressed 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 can be different if the price of the  bond is different to par (100).