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DEMYSTIFYING BONDS & HYBRIDS
Richard Murphy, CEO & Co-Founder XTB
DISCLAIMER
Australian Corporate Bond Company Ltd (ABN 34 169 442 657, Authorised Representative No.: 469037) (“ACBC”) is an Authorised Representative of Theta Asset Management Ltd (ABN 37 071 807 684, AFSL No.: 230920) (“Theta”). Theta is the Responsible Entity of the Australian Corporate Bond Trust (ARSN 603 010 779) and the issuer of the Exchange Traded Bond Units (“XTBs”). ACBC is the Securities Manager of the XTBs. ACBC and Theta will earn fees for making the XTBs available to investors, which is payable at the time that an Authorised Participant applies for an XTB.
An application was made to ASX for the XTBs to be quoted on ASX pursuant to the AQUA Rules. Further, Product Disclosure Statements relating to the relevant Class of XTB have been lodged with ASIC (each a “PDS”). No units will be issued until such time as ASIC and ASX have admitted that Class of XTBs to quotation. Applications will only be accepted from Authorised Participants pursuant to the relevant PDS. All other investors must acquire XTBs on ASX through an Authorised Participant or their Broker. This presentation does not constitute an offer of XTBs to any person.
The information contained in this presentation is confidential and may not be further disseminated to any person. The information contained in this presentation is general in nature and does not take into account any particular investors personal circumstances, objectives or needs. It is not personal financial product advice. It is only made available to wholesale investors within the meaning of section 761G of the Corporations Act (2001).
ACBC is solely responsible for the contents of this presentation. The contents of the PDS and this presentation are subject to change and ACBC makes no warranty, express or implied, as to the completeness of any statement contained herein nor does it represent that this presentation contains all of the information that an investor may require in order to assess the merits of an investment in XTBs.
The distribution of this document or any other material relating to XTBs, including the PDS, to persons outside of Australia may be restricted by law and any person who comes into possession of such documents should seek their own advice on, and observe any such restrictions.
Data in this presentation has been sourced from external parties believed to be reliable and has not been verified. Accordingly ACBC and Theta (and each of their directors, officers, consultants and employees) makes no warranty as to the accuracy or validity of any of the statistics quoted. To the extent permitted by law none of these parties are liable for any loss or damage arising from reliance on the content of this material.
XTB® is a registered trade mark of Global Bond Exchange Pty Ltd, a related body corporate of Australian Corporate Bond Company Limited.
© Copyright 2017 Australian Corporate Bond Company Ltd ABN 34 169 442 657. All rights reserved 2017
AGENDA
1. What is Fixed Income?2. Choice – Risk vs Return3. How bonds work4. Corporate bond XTBs – What are they?5. Questions
1. FIXED INCOME – THE BASICS
Fixed income:• A defensive low-risk anchor in your portfolio
• Total ability to predict your income & capital returns
Debt: Investors lend money to borrowers (companies + government)
Bond: A loan in the form of a tradable security
Maturity: The bond issuer pays you back:• Known Income (coupons) on a fixed schedule of dates
• The principal on a fixed date at maturity
Credit Rating: Focus on Investment Grade: low-risk, low-return, low price volatility, defensive, negatively correlated to shares
Issuers: Governments, Corporates, other bodies
Main Types:• Fixed-rate - coupon is fixed e.g. 4%
• Floating-rate - coupon linked to a moving benchmark
1. BONDS vs SHARES
Share investors OWN companiesBond investors are OWED money by companies
Share investors are looking for a return ON capitalBond investors are looking for return OF capital
Shares are perpetual – you never know future price
Dividends are discretionary - coupons are not
Bonds pay back $100 on a known date
Predictability is a key reason for investing in bonds - it comes from: • Known capital repayment• Known income amount• Known payment dates• And none of the above can change (or it’s a default)
There is no predictability with sharesBonds & shares go very well together
2. CHOICE: RISK vs RETURN
More return = More risk. ALWAYS
Don’t believe low-risk & high-return
Bonds are low-risk, low-return
Similar risk to Term Deposits
Capital is more at risk with equities - as expected
But minimise capital risk for defensive assets
Long-term volatility of equities 15.1% p.a. for ASX 200 issuers
2.7% for fixed-rate bonds
Ultra-low 0.45% for floating-rate bonds
3. HOW DO BONDS WORK?
100% PREDICTABLE CASH FLOWS
BONDS HELP YOU SLEEP AT NIGHT: 2016 Equity vs Bond Markets
BONDS: KEY TERMS
Focus on Yield to Maturity
Don’t be misled by other terms
PRICE vs YIELD: INVERSE RELATIONSHIP
DEFAULT RISK
What happens if it all goes wrong?
Risk the issuer doesn’t pay
Risk the issuer falls into financial difficulty
Credit rating - investment grade (IG)
Two IG bond defaults in 20 years
Probability of IG default - historically low
Senior bond ranking in a default
Bondholder recovery rates v shares
GOVERNMENT BONDS
Issued by Federal & State governments
Australian Government: AAA rating – highest rating possible
Therefore lowest yields
Yields below Term Deposit
Australian Government Bonds on ASX via the AGB range of securities
10, 20, 30 year bonds - strong returns when rates fell (2008-2015)
But with rising rates on the horizon - investor care needed
TERM DEPOSITS
TD RATES (major bank) 29 AUG
3 MONTH 1.75%
6 MONTH 1.80%
1 YEAR 1.85%
2 YEAR 2.30%
TDs are a form of fixed income
Money lent to a bank with interest
TDs lowest in recorded history (RBA)
SMSF - cash in Super <1%
CORPORATE BONDS
Issued by major ASX listed and large unlisted companies
Focus on Investment Grade• AA Rated (major banks) down to BBB- (Qantas, Aurizon, Lend Lease)
Yields range from ~ Term Deposit rates to low 4s• Would you lend $100,000 to Telstra for 2.5%?
• Would you lend $100,000 to Qantas for 3.5%?
• Would you lend $100,000 to Alumina for 4.1%?
• 2.5% TD to 3.5% bond = 40% increase in return
Corporate bonds issued in $500,000 to asset managers
Now on ASX via the XTB range of 50 listed company bond securities
Some more risk for some more return
Ability to access corporate bonds in $100 lots
HYBRIDS
Government and senior bonds are fixed income
Hybrids: share features + bond features
Income security - not fixed income
Complex instruments:• Designed by global regulators to protect banks
• Newer versions are all more equity-like
• Dividends are discretionary and may be non-cumulative
• No firm maturity - repayment can be deferred by issuer or APRA
• APRA can determine to defer repayment, garnish dividends, convert to equity
• If they’re converted to equity – it’s at the worst time for investor
HYBRIDS
Volatility: • Equity 15%
• Hybrids 6.5%
• Fixed-rate bonds 2.7%
• Floating-rate bonds 0.4%
Behave like bonds when shares thriving
Behave like equities when share prices stressed
The upside of bonds + the downside of equities
Hybrids not defensive and become correlated to equity when corrections occur
BOND ETFs & BOND FUNDS
Bond Funds - unlisted managed funds
Bond ETFs - ASX-listed index tracking funds
Both give widely diversified access to bond returns (often 400+ bonds)
Who chooses the bonds?• Bond Funds: professional fund manager
• Bond ETFs: ETFs track an index
Bond ETFs - generally much lower fees
Bond Funds - much more flexibility for manager and potential to outperform index
Bond ETFs - ask what’s in the index
Raging debate - active v passive
Ask about ‘prospective’ yields - yesterday’s returns are irrelevant
DIRECT BONDs vs ETFs/ FUNDS
Bond funds and ETFs are perpetual investments. A fund may start the year and end the year with a totally different set of bonds.
Why invest in bonds in the first place?• Predictable investment
• Low risk + defensive
Bonds maturing drives their predictability
You lose the predictability with perpetual funds
Are funds and individual bonds different asset classes?
What happens if rates rise?• Bonds = hold to maturity
• Funds = no maturity
Funds provide far greater diversification than individual investors can afford
How much diversification is needed?
WHO ARE BONDS SUITABLE FOR?
Sitting on cash & Term Deposits?• Some corporate bond yields higher than Term Deposits or cash returns
Diversification• Defensive asset class on ASX that provides capital stability and security• Diversify away from just equities and cash
Investor type• Investors with TDs and cash investments• Retirees looking for stable income• SMSFs• Alternative to fixed income funds and ETFs• Investors wanting less price volatility to hybrids and shares
HOW MUCH SHOULD YOU HAVE?
John Bogle (Vanguard founder) coined the phrase:
“Your bond allocation should equal your age”
4. WHAT ARE XTBs?
XTBs: WHAT ARE THEY?
XTBs: ASX top 100 corporate bonds• $100 securities on ASX
• Access for everyone
50 XTBs = 50 different bonds
All coupons + principal
Mature when bond matures
Bonds held in trust
Similar to single bond ETF that matures
Management fee
Yields range from TD yields to 4.1%
YTMTLS
7.75% 15 JUL 2020
Introducing Brian: A conservative investor approaching retirement
Retiring in 4 years, he wants to know what he will receive in the future
Wants higher yields than TDs but isn’t prepared to
put it all in sharesStill nervous after suffering
losses in GFC
BRIAN’S MOTIVATIONS
WHAT BRIAN NEEDS
KNOWN OUTCOMECASH FLOW MANAGEMENT
INTEREST RATE IMPERVIOUS CAPITAL
Brian wants to know what he will get and when he’ll get it right from the start
Known income and return of capital from maturing XTBs on an annual basis
Buy XTBs that mature each year & turn rate rises to his advantage*
* You must buy and hold to maturity
THE MATURITY LADDER PORTFOLIO
’18 YTMLLCLEND LEASE 5.5% 13 NOV
‘20 YTMAZJ AURIZON 5.75% 28 OCT
‘19YTMAWCALUMINA 5.5%+ 19 NOV
‘22 YTMDO1 DOWNER 4.5% 11 MAR
‘21YTMQF2QANTAS 7.5% 11 JUN
28
recap
• Corporate bonds can deliver a considerable uplift on TD rates • Individual bonds give certainty of capital and income irrespective of
rising or falling rates. Bond Funds / ETFs don’t• Hybrids are complex instruments. They are not defensive and are
correlated with shares
• XTB codes start YTM … Invest from $100• Trade exactly like shares, via your online broker or adviser
QUESTIONS?
THANK YOU
Visit our stand for a copy of our e-book“An Investors Guide to Fixed Income”