Further developing the Australian high yield bond market, FIIG Securities in 2019 started the Solactive FIIG Australian High Yield and Non-Rated Bond TR Index. The index has generated strong returns since inception and highlights the value of a high yielding allocation in fixed income portfolios.
This document has been prepared by FIIG Investment Strategy Group. Opinions expressed may differ from those of FIIG Credit Research.
Background
The Solactive FIIG Australian High Yield and Non-Rated TR Index (FIIG HY Index) is a rules-based, market value weighted index, which is unique in the Australian market for being the first of its kind. It is a benchmark that can be used to assess performance of AUD HY bond performance over a given period of time.
The index was officially launched on 1 August 2019, with data starting as far back as 2012.
Numerous HY indices exist in overseas fixed income markets, such as the US, however the sector remains in its infancy in Australia. To further improve transparency and develop the sector, the FIIG HY Index was developed.
A HY bond is a reference to a bond that is either not rated by a rating agency (I.e., S&P and Moody’s) or is assigned a sub-investment grade rating (i.e., a rating below BBB-).
In this article, we further discuss the FIIG HY Index and the improved returns an allocation to higher yielding bonds can provide.
The FIIG High Yield Index
Being a value weighted index, underlying bonds in the index are weighted according to their respective market value in proportion to the aggregate market value of the index.
The index has been developed in partnership with Solative AG, which is an innovative index provider that focuses on the development, calculation, and distribution of tailor-made indices across all asset classes. Solactive AG was established in 2007 and is headquartered in Frankfurt.
Similar to the ASX 200 or the Bloomberg AusBond Composite index, the FIIG HY Index is a benchmark index that can be used to track the performance of an asset class, in this case Australian HY bonds.
While the Australian iTraxx index focuses on credit spreads of the underlying constituents, the FIIG HY Index is a total return index that measures the price movement of the underlying bonds and assumes that all distributions are reinvested into the index.
The selection universe includes bonds domiciled in Australia with a minimum of AUD20m outstanding. It currently has 39 constituents across 31 issuers, with a duration of 1.51. The chart below shows the maturity and issuer breakdown.
Strong performance
Since inception on 31 December 2012, the FIIG HY Index has generated a cumulative return of 56.75% to 30 July 2021 or compound annual return of 5.36% over the same period.
This return also includes FY20, which saw credit spreads widen at the heights of the COVID-19 pandemic. Usually, during times of uncertainty and market wobbles, investors favour higher rated bonds over HY bonds, which are inherently riskier.
The weaker performance during this period is shown below, where the FIIG HY Index fell sharply, however was followed by a trend higher as HY bonds included in the index quickly recovered in most cases.
To give context for this move in markets, the Australian Itraxx index, which tracks the performance of the top 25 investment grade bonds, widened to 186 points in mid-March 2020, from 69 points at the start of March 2020. The higher the credit quality of a bond, the less likely it is to experience credit spread widening (and price weakness) during times of uncertainty.
However, a benefit of including a HY exposure in portfolios is that the higher coupon received can assist to cushion any capital losses should an investor wish to sell, generally providing a strong total holding period return.
Increasing returns
The table below highlights the returns the Index has generated, and despite a weaker annualised return of -0.48% captured during the peak of COVID-19, at three years the annualised return is 1.84% and further improves.
The past year has provided an annualised return of 6.24%, while it should be mentioned, some bonds included in the Index have lagged the recovery and are currently still trading at below par. These bonds include Lucas 2022 and Aviation Training Investments 2021.
While we believe a portfolio should be diversified with an allocation to investment grade bonds, the returns generated by the FIIG HY Index emphasis the improved returns that can be achieved through an allocation to HY bonds.
Conclusion
While exactly mirroring the index may be challenging for any individual investor given the supply and demand of all the constituents at any point in time, it is possible to replicate a significant part of it with portfolios of AUD250k (or more). The index demonstrates that significant diversification allows for the overall return of a portfolio to weather any temporary negative price movements or adverse credit events.
Click here to find out more about the Solactive FIIG High Yield and Non-Rated Index.