A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

Transcription

1 A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

2 The Australian fixed income market vs the Australian share market The Australian share market is dynamic. On any given trading day, share prices may move rapidly to reflect investors perceptions about the underlying companies. Due to this fast moving nature, the share market receives a lot of public attention. Faced with this constant stream of information, it s not surprising that shares capture the focus of many investors. In contrast, the bond market (which is largely comprised of fixed income securities) receives comparatively less attention from many investors. However, the extreme volatility of equities coupled with the demand for relatively safe income paying securities has seen some investors refocus a portion of investments on bonds. An appropriate fixed income allocation can provide portfolio diversification, reliable income and act as a hedge against inflation. Globally, bonds account for nearly twice as much investment as equities. In Australia, the bond market is approximately equal in size to the equity market. GROWTH OF AUSTRALIAN EQUITY AND FIXED INCOME MARKETS AUD$bn Sep 1992 May 1993 Jan 1994 Sep 1994 May 1995 Jan 1996 Sep 1996 May 1997 Jan 1998 Sep 1998 May 1999 Jan 2000 Sep 2000 May 2001 Jan 2002 Sep 2002 May 2003 Jan 2004 Sep 2004 May 2005 Jan 2006 Sep 2006 May 2007 Jan 2008 Sep 2008 May 2009 Jan 2010 Sep 2010 May 2011 Jan 2012 Sep 2012 May 2013 Jan 2014 Sep 2014 May 2015 Jan 2016 Australian Equity market size Australian Bond market size Source: RBA and ASX as at 29 February Past performance is not a reliable indicator of future performance. [2] A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

3 What is fixed income? Institutions such as governments and corporations borrow from investors by issuing fixed income securities (bonds). These securities obligate the issuer to make periodic coupon payments (usually twice a year) to investors as compensation for lending their funds to the issuer. These periodic payments are made until the maturity date at which point, the principal amount of the security becomes due and is repaid to the investor. While fixed income securities are traditionally viewed as being less risky than shares or listed property, they are not risk-free. RISK/RETURN FOR VARIOUS ASSET CLASSES OVER THE PAST 10 YEARS 7% 6% Australian Bonds 5% RETURN 4% 3% Cash Australian Equities International Equities 2% 1% 0% 0% 2% 4% 6% 8% 10% 12% 14% 16% Return = Average annual return Risk = Annual standard deviation Cash = RBA Cash Rate Index Australian Equities = S&P/ASX 200 Accumulation Index Australian Bonds = UBS Composite Bond Index International Equities = MSCI World ex-australia Index unhedged RISK Source: S&P, Bloomberg, MSCI, RBA and BlackRock. Data from 29 February 2006 to 29 February Past performance is not a reliable indicator of future performance. A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING [3]

4 Factors influencing bond prices The value of fixed income securities can fluctuate daily, albeit usually by less than shares. Two main factors influence change in value: INTEREST RATES A bond s change in value is driven largely by current and forecasted interest rates. For example if interest rates decrease, the value of a fixed coupon bond would typically increase. This increase in bond value would mean the fixed coupon, as a percentage of bond value, would decrease to be in line with interest rates. Alternatively, if market interest rates increase, the value of bonds would typically decrease. Interest rates and bond prices have an inverse relationship Interest rates Bond prices CREDIT STRESS If a bond issuer becomes financially stressed, they may propose varying the terms of their borrowing. This may include such measures as reducing the periodic coupon, extending the maturity or reducing a bond s face value (principal amount borrowed). In extreme cases an issuer may default, meaning they are unable to make coupon or principal repayments to bond holders. Credit stress and bond prices have an inverse relationship Credit stress Bond prices [4] A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

5 Issuers of fixed income securities The Australian fixed income market is made up of a diverse range of issuers. Australian Commonwealth Government Australian State Governments Domestic and Foreign Corporations Foreign Governments and Supranationals* Issues bonds commonly called treasuries Issue bonds commonly called semis Issue bonds collectively called credit Issue bonds commonly called sovereign and supranational * Supranationals are government supported organisations that transcend established national boundaries such as the Asian Development Bank. A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING [5]

6 Measuring fixed income performance Like other major asset classes, the performance of fixed income assets are tracked using established benchmarks. For Australian equities, benchmarks such as the S&P/ASX 200 Index or S&P/ASX All Ordinaries Index are used. In Australia, Bloomberg has been publishing fixed income benchmarks since 1988 and is the pre-eminent benchmark provider used by Australian bond funds. TOTAL RETURN OF SELECTED BENCHMARKS SINCE MAY % 800% 700% 600% 500% TOTAL RETURN 400% 300% 200% 100% 0% -100% May 1992 Apr 1993 Mar 1994 Feb 1995 Jan 1996 Dec 1996 Nov 1997 Oct 1998 Sep 1999 Aug 2000 Jul 2001 Jun 2002 May 2003 Apr 2004 Mar 2005 Feb 2006 Jan 2007 Dec 2007 Nov 2008 Oct 2009 Sep 2010 Aug 2011 Jul 2012 Jun 2013 May 2014 Apr 2015 Mar 2016 S&P/ASX 200 Accumulation Index Bloomberg AusBond Government Inflation Index Bloomberg AusBond Composite Index Bloomberg AusBond Treasury Index Source: S&P, Bloomberg and BlackRock as at 29 February For illustrative purposes only. Past performance is not a reliable indicator of future performance. [6] A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

7 ishares Australian fixed income ETFs: ishares CORE COMPOSITE BOND ETF * (IAF) Treasury 47.92% Government Related 40.40% Coporates 10.46% Covered 0.98% Cash and/or Derivatives 0.13% The ishares Core Composite Bond ETF (the Fund ) aims to provide investors with the performance of the market, before fees and expenses, as represented by the Bloomberg AusBond Composite Index SM (the Index ). The Fund invests primarily in investment grade fixed income securities issued by the Australian Commonwealth Government, Australian State-Governments, Supranational and Sovereign agencies and corporate debt issues that form the Index, and seeks to achieve its objective by employing an optimisation (stratified sampling) strategy to track the performance of the Index. The Bloomberg AusBond Composite Index SM is designed to measure the performance of the Australian bond market which meets certain investment criteria and covers fixed interest bonds issued in the Australian debt market under Australian law. The Bloomberg AusBond Composite Index SM, is an index of valuations of the debt securities which are included in it. ishares TREASURY ETF (IGB) Governments 100% The ishares Treasury ETF (the Fund ) aims to provide investors with the performance of the market, before fees and expenses, as represented by the Bloomberg AusBond Treasury Index SM (the Index ). The Fund invests primarily in investment grade fixed income securities issued by the Australian Commonwealth Government that form the Index, and seeks to achieve its objective by employing a full replication strategy to track the performance of the Index. The Bloomberg AusBond Treasury Index SM is designed to measure the performance of the Australian bond market which meets certain investment criteria and covers fixed interest bonds issued in the Australian debt market under Australian law. The Bloomberg AusBond Treasury Index SM, a sub-index of the Bloomberg AusBond Composite Index SM, is an index of valuations of the debt securities which are included in it. ishares GOVERNMENT INFLATION ETF (ILB) Governments 100% The ishares Government Inflation ETF (the Fund ) aims to provide investors with the performance of the market, before fees and expenses, as represented by the Bloomberg AusBond Inflation Government Index SM (the Index ). The Fund invests primarily in investment grade fixed income securities issued by the Australian Commonwealth Government and Australian State-Governments that form the Index, and seeks to achieve its objective by employing an optimisation (stratified sampling) strategy to track the performance of the Index. The Bloomberg AusBond Inflation Government Index SM is designed to measure the performance of the Australian bond market which meets certain investment criteria and covers fixed interest bonds issued in the Australian debt market under Australian law. The Bloomberg AusBond Inflation Government Index SM is an index of valuations of the debt securities which are included in it. Source: BlackRock. Fund data as at 31 March For illustrative purposes only. BlackRock accepts no responsibility for completeness of this information and any inaccuracies contained therein. This is not a recommendation to invest in any particular financial product. No analysis of their suitability was conducted and no statement of opinion in relation to their suitability is provided. * As at 28 April 2016, the ishares Composite Bond ETF changed its name to ishares Core Composite Bond ETF. THE i SHARES AUSTRALIAN EQUITY EXCHANGE TRADED FUND (ETF) SERIES [7]

8 The benefits of fixed income Diversification and income generation may be two reasons why an investor would make an allocation to Australian fixed income within their portfolio. DIVERSIFICATION Fixed income can be a great diversifier of portfolios as the asset class is considered highly complementary with equities. This is because fixed income has historically been a less volatile asset class than shares, and often sees increases in value as the value of shares decreases. The diversification benefits of Australian fixed income were highlighted in the depths of the Global Financial Crisis (GFC). Looking at the seven month period from September 2008 to March 2009 in the chart below, Australian fixed income saw substantial positive returns in the face of large drops and volatility in the equity market. CUMULATIVE RETURNS POST-GFC 20% 10% 0% -10% -20% -30% -40% 1 Sep Sep Sep Oct Oct Nov Nov Dec Dec Jan Jan Feb Feb Mar Mar Mar 2009 S&P/ASX 200 Accumulation Index UBS Composite Bond Index * Source: UBS, ASX, Bloomberg, BlackRock, as at 31 July Past performance is not a reliable indicator of future performance. * As at 29 September 2014, the USB Composite Bond Index changed its name to Bloomberg AusBond Composite Index. [8] A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

9 Diversification a case study In fact, even a small allocation to Australian fixed income can lead to improved portfolio returns with lower risk. For example, a 10% allocation to Australian fixed income (represented by Bloomberg AusBond Composite Index in the table below) alongside an Australian equity holding (represented by S&P/ASX 200 Accumulation Index in the table below), sees overall portfolio risk decrease in all three time periods while simultaneously increasing returns over five years. Over 3 years 31 Mar Mar 2016 Over 5 years 31 Mar Mar 2016 Over 10 years 31 Mar Mar 2016 RBA Cash Rate Index Return 2.37% Return 3.01% Return 4.13% Australian Equity 100% Risk 12.61% Risk 12.52% Risk 14.23% Return 5.40% Return 5.70% Return 4.43% Australian Equity 90% Australian Fixed Income 10% Risk 11.41% Risk 11.23% Risk 12.72% Return 5.39 % Return 5.70% Return 4.64% Potential benefit to Investor Risk adjusted return Risk adjusted return Risk adjusted return Source: BlackRock, as at 31 March Sharpe ratio is used to calculate the risk adjusted return. RBA Cash Rate Index is used as the risk free rate. For illustrative purposes only. This is not a recommendation to invest in any particular financial product. No analysis of their suitability was conducted and no statement of opinion in relation to their suitability is provided. Past performance is not a reliable indicator of future performance. A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING [9]

10 INCOME GENERATION A key feature of fixed income assets is their income paying power. Since April 2000, Australian fixed income has yielded an average of 5.1% per annum compared with Australian equities at 4.2% per annum. Many companies believe they face an uncertain future and this may be the reason they have retained a larger portion of their earnings. Investors are therefore seeing declining dividend yields. Australian fixed income securities can be a reliable source of income for investors. BENCHMARK YIELD 9% 8% 7% 6% YIELD 5% 4% 3% 2% 1% 0% May 2000 Sep 2000 Jan 2001 May 2001 Sep 2001 Jan 2002 May 2002 Sep 2002 Jan 2003 May 2003 Sep 2003 Jan 2004 May 2004 Sep 2004 Jan 2005 May 2005 Sep 2005 Jan 2006 May 2006 Sep 2006 Jan 2007 May 2007 Sep 2007 Jan 2008 May 2008 Sep 2008 Jan 2009 May 2009 Sep 2009 Jan 2010 May 2010 Sep 2010 Jan 2011 May 2011 Sep 2011 Jan 2012 May 2012 Sep 2012 Jan 2013 May 2013 Sep 2013 Jan 2014 May 2014 Sep 2014 Jan 2015 May 2015 Sep 2015 Jan 2016 Bloomberg AusBond Composite Index yield S&P/ASX 200 Index yield Source: S&P, Bloomberg, BlackRock. Data as at 28 Feb S&P/ASX 200 Index yield is the rolling 12 month historic gross dividend yield, excluding franking credits. Bloomberg AusBond Composite Bond Index yield is the yield to maturity. Past performance is not a reliable indicator of future performance. [10] A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING

11 ishares ETFs making fixed income easy Market access ``Use one trade to gain exposure to large baskets of bonds tracking recognised indices ``Access available through a security that trades like a stock during local market hours Low minimum investment ``Typical minimum investments for direct fixed income have been prohibitively high, unlike equities, which can be readily traded Portfolio diversification ``Fixed income may be considered an essential component of a well-balanced portfolio ``Adding fixed income to portfolios can help improve the overall risk/return profile ishares, the leading provider of ETFs globally, has led the development of fixed income ETFs since 2002, and represent approximately 52% market share of total fixed income ETF assets globally: ishares FUNDS REPRESENT 52% OF GLOBAL FIXED INCOME ETF ASSETS $600 $500 TOTAL AUM USD$bn $400 $300 $200 $100 $ YTD All other fixed income ETFs ishares Source: Bloomberg and BlackRock, as at 29 Feb For illustrative purposes only. This is not a recommendation to invest in any particular financial product. No analysis of their suitability was conducted and no statement of opinion in relation to their suitability is provided. A GUIDE TO AUSTRALIAN FIXED INCOME INVESTING [11]

12 Want to know more? blackrock.com/au/ishares IMPORTANT INFORMATION Before investing in an ishares exchange traded fund, you should carefully consider whether such products are appropriate for you, read the latest product disclosure statement or prospectus available at and consult an investment adviser. This material is issued by BlackRock Investment Management (Australia) Limited ABN , AFSL (BlackRock Australia). This material provides general information only and has not been prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. Any potential investor should consider the latest product disclosure statement or prospectus in deciding whether to acquire, or to continue to hold, an investment in any BlackRock fund. This material is not a securities recommendation nor is it an offer or solicitation with respect to the purchase or sale of any securities in any jurisdiction. BlackRock Australia is the responsible entity and issuer of units in the Australian domiciled ishares ETFs referred to in this material. BlackRock Australia is the local agent and intermediary for non-australian domiciled ishares ETFs referred to in this material that are issued by ishares, Inc. ARBN formed in Maryland, USA; and ishares Trust ARBN organised in Delaware, USA (International ishares ETFs). BlackRock Fund Advisors (BFA) serves as an advisor to the International ishares ETFs, which are registered with the United States Securities and Exchange Commission under the Investment Company Act of BFA is a subsidiary of BlackRock Institutional Trust Company, N.A. (BTC). BTC is a wholly-owned subsidiary of BlackRock, Inc.. An ishares ETF is not sponsored, endorsed, issued, sold or promoted by the provider of the index which a particular ishares ETF seeks to track. No index provider makes any representation regarding the advisability of investing in the ishares ETFs. Further information on the index providers can be found on BlackRock Australia s website terms and conditions. BlackRock Australia, its officers, employees and agents believe that the information in this material and the sources on which the information is based (which may be sourced from third parties) are correct as at the date of publication. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for this information is accepted by BlackRock Australia, its officers, employees or agents. Except where contrary to law, BlackRock Australia excludes all liability for this information. Any investment is subject to investment risk, including delays on the payment of withdrawal proceeds and the loss of income or the principal invested. While any forecasts, estimates and opinions in this material are made on a reasonable basis, actual future results and operations may differ materially from the forecasts, estimates and opinions set out in this material. BlackRock Australia does not guarantee the repayment of capital or the performance of any product or rate of return referred to in this material. Past performance is not a reliable indicator of future performance. No part of this material may be reproduced or distributed in any manner without the prior written permission of BlackRock Australia BlackRock, Inc. All Rights reserved. BLACKROCK, ishares and the stylized i logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. AUS ish