Investing

Selecting XTBs taking diversification into account

The more XTBs you include in your portfolio, the more the overall yield moves towards the average of the universe of XTBs.

But how many bonds gives you enough diversification?

The more XTBs you include in your portfolio, the more the overall yield moves towards the average of the universe of XTBs.

But how many bonds gives you enough diversification?  This is a matter of opinion rather than fact.  Many advisers would consider that unlike equities you don’t need to cover all industry types to get appropriate diversification. Some fund managers would argue you need lots of bonds to get proper diversification, but they also argue you need hundreds of equities to be diversified, yet people often own smaller portfolios of equities.

Fund managers make money by diversifying so they have one view, whereas there has always been an investor appetite in Australia for holding securities directly.

Corporate bonds are loans to a corporate. If two companies have the same credit standing, then your credit risk is very similar irrespective of industries.  For example, if Woolworths and Telstra had the same credit rating, then you could consider their bonds (of the same term) as comparable.  Whereas their equites are fundamentally different.

Therefore, many commentators consider 5-10 bonds as providing enough diversification for most investors, compared with say 15-25 equities needed to cover industries and sectors.

In this section, we have focused on constructing a portfolio of 8 XTBs to give you a sense of a reasonably diversified portfolio.

How to narrow your selection

There are a number of filters you can use to narrow your selection. Some of these include:

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