Tuesday 22 October 2013 by FIIG Research Legacy

From the Trading Desk (22/10/13)

Analysis of our clients’ returns over the past three years yields some interesting results. Also please note an important comment on today’s inflation announcement

From the Trading Desk

Today the Australian Bureau of Statistics will release the latest quarterly inflation figure in the form of the Consumer Price Index (CPI). This is an important release, as economists are expecting the year-on-year figure to come out at 1.8%, much weaker than the prior reading of 2.4%. Anything weaker than 2.0% has the potential of creating a negative knee-jerk reaction in inflation-linked bonds.

If that occurs, this could provide a great opportunity to pick up these assets at good levels. Bear in mind that when you invest in an inflation linked product, you are investing in the overall inflation rate until the maturity of the bond, not just the current reading. Any sign of prolonged weakness will be met by the Reserve Bank of Australia with further rate cuts, which should in turn reverse the overall course of inflation.

The Praeco 2020 Index Annuity Bond has been one of our top picks recently, but unfortunately supply has now dried up in this stock. Here are some of the best inflation linked products available along with the yields we are expecting post-CPI.

Active portfolio management vs hold-to-maturity – the difference may surprise you

Last month I was asked by our marketing division if I could provide them with estimates of the average returns our clients had achieved from investments made through FIIG over the last three years. I probably agreed too quickly to this, as it proved to be more complicated than I originally thought. I had to separately calculate the returns on positions held currently, positions that had matured, positions that had been sold prior to maturity, and of course term deposits. This analysis covered over 40,000 trades and positions across over 5,000 clients.

After weeks of data mining, I finally arrived at the answer, which I forwarded on with the request that I never be asked to do this again. However, through the complexity of the process I discovered something very interesting that is well worth passing on.

Over the past three years - since September 2010 to be precise – the average annualised return clients have made on assets that were held to maturity was 12.88%. At first this seemed too high, but then I realised that this was inclusive of assets that were picked up very cheaply during the Global Financial Crisis (GFC), and it makes perfect sense.

But that is not the interesting part.

Over the same period, the average annualised return clients have made on assets that were sold prior to maturity was 30.04%. Not only is that well over twice that achieved by holding assets to maturity, it also compares favourably to equity returns but from a lower risk fixed income portfolio. Again, this is extreme due to the inclusion of assets acquired during the GFC period, but it clearly highlights the advantage of actively managing your fixed income portfolio.

Investors who believe the outright yields on fixed income assets are too low would do well to consider enhancing their return by regularly reviewing their portfolio and adjusting the constituents to maximise returns.