Income Options - focus for SMSF

[sydboy007]

I wish these offerings were listed on the ASX like they are in the US!

+100

Sometimes I feel we're stone age in Australia in terms of bonds and fixed income in this country. Access to it is rather difficult and on the expensive side.

Hopefully within the next couple of years there will be some development of ASX listed bonds - less hybrids and more bonds please

 

[sydboy007]

The below is from the latest AYF Australian Enhanced Income Fund July 2013 Investment Update and NAV.

I'll say that over the last 3 months the volatility of the ASX has been fairly high - from nearly 5200 to 4633 then back up 5125. Compare that to AYF which started at 6.43 dropped to 6.24 and is currently at 6.35. I know hybrids carry more risk, and I don't see the NAV of AYF going anywhere fast, but by investing across a decent range of hybrids it at least lets you mitigate against getting it wrong if you can only afford to buy into a few hybrids. The gross yield of around 7% is also pretty competitive in the current financially repressed environment.

The below chart is similar to one that FIIG securities produced a few months back. Boring bonds quite often outperform shares on a risk adjusted basis.

In concert with last month’s commentary where we compared the absolute and volatility adjusted returns of the All Ordinaries Accumulation Index and the Elstree Hybrid Index since 1999 this month we thought we would articulate the same information but express it in a slightly different way. The equity risk premium is the excess return investors expect to receive above the risk free government bond rate for investing in the riskier asset class. The long term equity risk premium is around 400 basis points over the risk free government bond rate. The chart overleaf depicts the ‘premium’ in Australia since 1979. Where the line intersects with the horizontal axis the return from that point to the present represents a zero excess return. Where the line is above the horizontal axis the equity excess return is
negative (i.e the risk free government bond rate return from that point to the present exceeds the equity market return) and where the line transcends the horizontal axis the equity return exceeds the risk free government bond rate return. The chart serves to highlight 2 things:
(i) the timing of entry and exit into and out of the equity market is important and
(ii) equities have struggled to out-perform the risk free government bond rate for any sustained period over the last 35 years.

To highlight the latent value in hybrids we have drawn a line on the chart at 3.5% above the horizontal axis. This line represents the excess return above the risk free government bond rate you currently receive for investing in a portfolio of hybrid securities. You will note that the equity excess return barely transcends this line (the latest 12 months notwithstanding). This demonstrates the superior absolute return you can expect to earn by investing in hybrids over equities if the history of the last 35 years is anything to go by. And if we consider the lower volatility of hybrids over equities the argument becomes even more compelling than it already is.

 

[sydboy007]

Just saw this at yellow brick road

http://www.ybr.com.au/savings/index.cfm

Smarter Money is an independently rated and recommended savings solution that targets outperforming the Reserve Bank of Australia’s cash rate plus 1% per annum after all fees. Cash rate by 1% - 2% per annum after all fees, over rolling 12 month periods.

Smarter Money invests in a conservative portfolio of Australian bank deposits and investment-grade bonds issued mainly by banks. By aggregating individual investors' cash, Smarter Money offers access to 'institutional' returns usually unavailable to retail investors.

Since 1st July 2012, Smarter Money returned 6.7% per annum (at 30/6/13) after all fund fees and charges, depending on the investor type. Smarter Money has significantly outperformed its benchmark, the UBS Bank Bill Index, which is made up of cash securities and bank bills, and peer funds. Past performance does not, however, assure future returns.

Smarter Money has been independently reviewed and rated as investment grade by several research houses. Please contact us to obtain copies of the Ratings Reports. These Ratings are only one factor to be taken into account when deciding whether to invest. Smarter Money targets holding 30-50% of its investments in Australian bank deposits and RBA repurchase-eligible securities with the balance invested in Australian floating-rate bonds that generally move in line with the RBA cash rate. As a minimum, the bonds must have an S&P rating of Investment Grade. Smarter Money does not invest in any YBR-related securities.

Whilst Smarter Money is not a bank deposit it is a managed investment scheme registered and regulated by the Australian Securities and Investments Commission (ASIC).

All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. To understand Smarter Money’s risks better, please refer to the detailed "Risks" tab below and/or the PDS.

YBR Smarter Money Fund Product Disclosure Statement re-issued

The Product Disclosure Statement (PDS) for the YBR Smarter Money Fund has been re-issued and is effective from the 20th of May, 2013. The PDS contains updated information and reflects the new responsible entity of the Fund, Select Asset Management Limited. There have been no material changes to the Fund’s investment strategy and fees remain the same. Click here to view a copy of the PDS. Alternatively you can request a free paper copy by contacting YBR on 1800 927 927.

 

[sydboy007]

Something I was looking at today in regards to ILBs (inflation linked bonds) is they seem to provide a much better after tax return than FRNs (floating rate notes).

Another benefit is that ILBs have seen little margin compression with the RBAs interest rate cuts as the CPI hasn't really changed a lot but BBSW has dropped quite a bit.

It's probably easiest to explain it as (within an SMSF):

ILB - CPI 2.5% per year with 4% margin = 6.5% rate of return

Over a 10 year period you will receive capital growth for CPI of ~ 27.5% ie if you paid $50K for the bond you would receive around $63.75K at maturity. That $13.75K in "interest" appears to be tax free.

I estimate over the 10 year period you will receive around $18.7K in payments net of tax

In the end the 50K you invested is returned as nearly $82.5K or $32.5K of earnings after tax

FRN - 6.5% per year

You will receive the 50K at maturity and nearly $27K in interest payments after tax for a total return of $77K

So the ILB gives you ~ 32.5K of net return compared to the $27K of the FRN which is like an extra 1.8% compounding return for the ILB over the FRN.

In the current financially repressed worl we live in a 1.8% difference is pretty big

See attached spreadsheet for how I've done my calculations

 

[blue0810]

don't know much about bonds but I can see ETFs ILB ,IAF are
going south very quick.

 

[sydboy007]

don't know much about bonds but I can see ETFs ILB ,IAF are
going south very quick.

What's your reasoning behind that?

ETFs cover basically every asset class their is

 

[Ves]

What's your reasoning behind that?

ETFs cover basically every asset class their is

Syd, I think he means the stock prices on IAF and ILB.

 

[blue0810]

Syd, I think he means the stock prices on IAF and ILB.

+1
Thanks for decrypting my post.

 

[sydboy007]

+1
Thanks for decrypting my post.

Ah

mosst Govt bonds are too low yielding. I'd prefer a good corporate bond. Most seem to be far more solvent than a lot of Govts these days

 

[sydboy007]

just received this from FIGG securities if anyone is looking for a decent yielding bond

FIIG has just direct bonded a June 2030 Inflation Indexed Annuity for Plenary Justice (SA) Pty Ltd.

They were established in 2005 to design construct and maintain nine police and court facilities across 6 locations in SA and are rated A3 (stable) by Moody’s. It is available in parcel sizes of down to 10k at inflation +4.20% (currently 6.7%).

A parcel of 10k will cost $9,370.01. Detailed Research and cashflows are available - please get in touch and I will provide individually, but in summary:

$9,370.01 invested today returns $16,202.84 in quarterly payments at an inflation assumption of 2.5%

A more detailed summary will come later today but we wanted to alert our clients to this immediately as it is a very attractive level at inflation +4.20%, and it almost exactly matches the maturity of the 2030 Sydney Airport inflation linked bond, which works very well in combination.

Supply is limited as it was with the previous Praeco annuity, which went very quickly. We are taking orders now.

 

[sydboy007]

This ishares composite bond fund is paying a pretty decent yield in the current interest climate at 5.5%

http://au.ishares.com/fund/fund-overview-IAF-ASX.do


Russel offers an even higher yielding corporate bond fund at 6.14% running yield

http://www.russell.com/AU/exchange-traded-funds/products/RCB/

Very tempting as the next 10K purchase in my SMSF. 3.5%+ over inflation for minimal risk. Seems like a good deal to me.

 

[sydboy007]

https://www.fiig.com.au/news-and-re...2013/09/24/the-outlook-for-term-deposit-rates

Looks like TDs ain't going to improve for lenders anytime soon.

Last week the Commonwealth Bank issued US$3 billion of bonds in the US corporate bond market. The majority, US$2bn, were floating rate notes for a three year term with an interest rate of 3 month US LIBOR plus 50 basis points (bps). The 3 month US LIBOR rate is the benchmark rate which will fluctuate over the life of the bond, and the 50 bps (equals 0.5%) is the fixed margin. With 3 month US LIBOR at 25 bps, the total cost of the bonds for the first quarter will be approximately 75 bps or 0.75%, a very low cost for CBA.

The other US$1bn was fixed rate at 2.5% for a five year term. You might wonder how the bond issue impacts term deposit interest rates. Well, the CBA, like other major Australian banks must raise funds for operations and it has many markets it can access to do this: international and domestic over the counter wholesale bond markets, the ASX listed fixed income market, share markets and of course deposits. It makes sense to seek the lowest cost of funds (although there are many considerations in funding) to maximise profit and issuing bonds in international markets at the moment is cheap.

It’s interesting to note CBA issued the “floaters” for three years, perhaps that’s about the time span that they think interest rates will stay low. However, CBA was prepared to fix for longer, possibly expecting interest rates to rise in the medium term. Whatever happens to interest rates, the CBA, like most other bond issuers, hedges the different outcomes by issuing both fixed and floating rate bonds.

CBA have given us some clues about their US interest rate expectations. Having an opinion about the direction of interest rates is important in fixed income. That way you can best decide how to weight the defensive portion of your portfolio; that is the split between fixed and floating rate investments.

There are many interest rate indicators and the most common is the bank bill swap rate (BBSW) which becomes known as Swap after six months. The chart shows BBSW/ Swap (the banks’ expectations of interest rates) and this is known as a yield curve. Over the next three years banks expect rates to remain low and climb gradually. BBSW is virtually unchanged in a years’ time and after three years the expectations are that it has risen by just 0.75%.

The chart also shows major bank term deposit rates for $25,000 out to three years. The margin over and above BBSW is approximately 1.0% or 100 bps for the next year (3.60% return), but then narrows and is just 65 bps (3.90% return) for a three year term.

The implication is that investors should not expect term deposit rates to improve for at least a year and then expect a slow rise, assuming the yield curve holds true. If you are reliant on term deposits for income, then there has never been a better time to consider alternatives. A low risk corporate bond portfolio, including fixed and floating rate bonds would be an excellent way to increase return.

 

[craft]

This ishares composite bond fund is paying a pretty decent yield in the current interest climate at 5.5%

Yeild to maturity is 3.56% and modified duration is 4.09 years.

http://au.ishares.com/fund/fund-overview-IAF-ASX.do


Russel offers an even higher yielding corporate bond fund at 6.14% running yield

Yield to maturity is 3.42% and modified duration is 2.21 years.

http://www.russell.com/AU/exchange-traded-funds/products/RCB/

Very tempting as the next 10K purchase in my SMSF. 3.5%+ over inflation for minimal risk. Seems like a good deal to me.

It’s the yield to maturity that you will receive as the holder of these instrument not the running yield. And if interest rates move within the modified duration time frame you stand to make a capital loss/gain. Given interest rates are low and tapering looms out there somewhere, negative changes to capital are a real possibility.

Be fully informed and aware with these products.

Chasing yield without fully understanding the implications of the product has a long tradition of bitting people on the bum.

 

[McLovin]

Isn't modified duration measured in % and Macauley measured in years?

 

[craft]

Isn't modified duration measured in % and Macauley measured in years?

Modified duration shows the duration including a 100 basis point increase in yield - it is expressed in years.
The product suppliers only provided Modified not Macaulay’s. Modified will always be a bit lower.

 

[McLovin]

Modified duration shows the duration including a 100 basis point increase in yield - it is expressed in years.
The product suppliers only provided Modified not Macaulay’s. Modified will always be a bit lower.

Thanks for clarifying. I can't say I've ever tried to put together a bond portfolio.

ETA: craft, I'm a little confused here...

Macaulay duration and modified duration are both termed "duration" and have the same (or close to the same) numerical value, but it is important to keep in mind the conceptual distinctions between them. Macaulay duration is a time measure with units in years, and really makes sense only for an instrument with fixed cash flows. For a standard bond the Macaulay duration will be between 0 and the maturity of the bond. It is equal to the maturity if and only if the bond is a zero-coupon bond.

Modified duration, on the other hand, is a derivative (rate of change) or price sensitivity and measures the percentage rate of change of price with respect to yield. (Price sensitivity with respect to yields can also be measured in absolute (dollar) terms, and the absolute sensitivity is often referred to as dollar duration, DV01, PV01, or delta (δ or Δ) risk). The concept of modified duration can be applied to interest-rate sensitive instruments with non-fixed cash flows, and can thus be applied to a wider range of instruments than can Macaulay duration.

http://en.wikipedia.org/wiki/Bond_duration#Modified_duration

 

[craft]

Thanks for clarifying. I can't say I've ever tried to put together a bond portfolio.

and now's not the time to change that either.

 

[craft]

ETA: craft, I'm a little confused here...

For your sick pleasure here is the formula.



Yes it can be used as a sensitivity measure if compared back against Macaulay.

My intention was not to get into the complexity of price sensitivity here. – modified duration which is provided by the product suppliers is an adequate duration measure for trying to get across the message that these products have an effective fixed duration which can lead to capital losses if interest rates move within that period.

Trying to start with 101 before going to advanced. (actually just trying to prompt some who might be investing in these products to dig a little deeper before the market delivers any unexpected lesson)

 

[McLovin]

For your sick pleasure here is the formula.

View attachment 54517

Yes it can be used as a sensitivity measure if compared back against Macaulay.

My intention was not to get into the complexity of price sensitivity here. – modified duration which is provided by the product suppliers is an adequate duration measure for trying to get across the message that these products have an effective fixed duration which can lead to capital losses if interest rates move within that period.

Trying to start with 101 before going to advanced. (actually just trying to prompt some who might be investing in these products to dig a little deeper before the market delivers any unexpected lesson)

Got it!

Thanks mate.

 

[sydboy007]

It’s the yield to maturity that you will receive as the holder of these instrument not the running yield. And if interest rates move within the modified duration time frame you stand to make a capital loss/gain. Given interest rates are low and tapering looms out there somewhere, negative changes to capital are a real possibility.

Be fully informed and aware with these products.

Chasing yield without fully understanding the implications of the product has a long tradition of bitting people on the bum.

Thanxs. I should have realised as I focus on the YTM as that's what I'll get. Running Yield is only of interest to se the historical performance.

back to thinking about getting some SYd Airport 2030 ILBs since they're back to offering aroudn the 4% + CPI mark.