Interest rate movements & bond fund performance
Now’s the time to make sure your clients are on the right path.
We have had a lot of conversations with advisers around interest rates and bond yields – where do they go and how quickly?
Many advisers are now starting to think about how best to talk to clients about interest rates movements and the effect on performance of their fixed income bond ETFs and managed funds.
The inverse relationship
If rates go up then bonds sell off. This means the capital price of their fund will fall. If a client asked in a meeting if this will happen again in the future what would your response be?
If interest rates go up then this is also true of XTB price (it falls). However a key benefit of an XTB is that it has a set maturity date. This means as an XTB gets closer to maturity, rate movements have less of an effect on the capital price, as you know an XTB will mature at $100, absent of a default.
XTB created portfolios to make it easier for you to help your clients. Our portfolios and Separately Managed Accounts (SMAs) continue to outperform other fixed income listed investments (see table 1).
XTB Performance: Inception to 31st March 2018
- High Yield – 5.56% p.a.
- Concentrated High Yield –5.50% p.a.
- Maturity Ladder (S1) – 5.33% p.a.
- Maturity Ladder (S2) – 5.96% p.a.
- Cash Plus (Floating-Rate Notes) – 3.03% p.a.
- We also have an XTB SMA available on Praemium and Macquarie Investment Wrap. This portfolio was created on 8 February 2017 and since inception has returned 10% p.a.
Read more on the inverse relationship of price and yield.
What is the market telling us?
Many people have forecast a rate increase in Australia this year, however markets are not reflecting any movement in the RBA cash rate for more than a year. The US have increased their Fed funds rate once this year with two more rate rises expected this year. The US rate increase has helped move the 10-year Australian Government Bond rates to 2.8% which is up from 2.63% on 1st January.
Shorter dated corporate bonds which XTBs track are more influenced by the 3 or 5-year Government Bond rather the more quoted 10-year Government bond rate. The 3-year Government Bond has remained flat since the beginning of the year at ~2.18% however the 5-year Government bond has risen in yield (bonds sold off) to 2.43% from 2.28% on 1st January.
You can see from the chart below that the market isn’t pricing in a full rate rise until August 2019 or another 15 months from now.
The chart below shows that the market isn’t currently pricing in a full rate rise until August 2019, or another 15 months from now.
Chart 1: ASX 30 Day Interbank Cash Rate Futures implied yield curve as at 30 April 2018
XTB portfolio performance vs other ETFs that have 1-year performance
Most of the XTB portfolios were created on 30 August 2016 with the aim of helping advisers create portfolios to meet different client needs.
Chart 2 shows the performance of four XTB portfolios since 31 December 2016 and compares them to:
- Betashares Australian High Interest Cash ETF (AAA)
- iShares Core Composite Bond ETF (IAF)
- Vanguard Australian Fixed Interest Index EFT (VAF) and
- Vanguard Australian Corporate Fixed Interest Index ETF (VACF)
Over the 15-month year period, the 3 XTB fixed-rate portfolios outperformed the other fixed bond ETFs and the Cash Plus outperformed AAA.
Focus on YTM and be aware of performance before fees
To remind you what to look at when selecting XTBs or a bond fund/ETF, the key benchmark is what is the expected yield to maturity after fees.
Yield to maturity is a forward-looking number that gives you what you are expected to earn if you hold to maturity. Remember, you never know that in a fund as they don’t mature, they are perpetual. Something else to consider when you look for the yield to maturity of a fund or ETF, is that they don’t show the YTM after fees. You will need to deduct their fee to get closer to their real yield to maturity.
Chart 2: Performance of XTB recommended portfolios vs 4 comparative bond ETFs 31 Dec ’16 to 31 Mar ’18
Table 1: Returns and Volatility
|ASX ETFs||Absolute Returns||Annualised Volatility|
|AAA – Cash ETF||3.2%||0.1%|
|Concentrated High Yield||11.0%||1.4%|
|Maturity Ladder S1||9.0%||0.9%|
|Floating XTBs – Cash Plus||5.1%||0.2%|
The pricing data used to determine the returns in the ASX ETFs is taken using the last trade price on the day and not the NAV. We have assumed reinvestment of distributions as at ex-dividend date unit price. Comparison ETFs were chosen based on them having a track record of greater than 12 months, there may be other fixed income ETFs which did not have a track record of more than 12 months that may have achieved different total return outcomes. Past performance is not a guarantee of future performance. Some of the ETFs invest in bank deposit accounts, Australian Treasury, Australian semi-government entities, supranational and sovereign entities as well as Australian corporate entities, while XTBs provide exposure to Australian corporate bonds only.
Our portfolios are currently showing a total portfolio yield to maturity of up to 3.48% after fees. Call our sales team on 1800 995 993 to discuss which portfolios work for you and your client. We can also create a personalised cash flow PDF for your client. Alternatively, can download the latest portfolio price sheets.
Source: Australian Corporate Bond Company and Bloomberg as at 31 March 2018