“In fiction: we find the predictable boring.
In real life: we find the unpredictable terrifying.”
Predictability from your investments is far from boring
Most funds see investor redemptions as a failure, a possible sign of customer dissatisfaction. At XTB, returning capital to our investors is viewed as a sign of success. It means we have achieved what we set out to do.
To date, investors holding their XTBs to maturity have received over $160 million in face value repayments. By the end of 2020 this number is likely to approach $200 million. On top of this, investors holding XTBs have also received regular income payments of more than $50 million.
Predictability in an unpredictable world
XTBs represent a fraction of a corporate bond, which is traded on ASX. They provide regular income AND a known outcome. They can help add some predictability to investment portfolios in a very unpredictable world.
How XTBs work:
Advantages of mirroring a single bond vs pooled investments
Unlike bond funds and ETFs which are pooled investments, each XTB gives investors exposure to a single corporate bond. In turn, this allows investors to tailor their portfolios. They can choose payment and maturity dates to suit their cash flow requirements. This transparency has the added benefit that investors know exactly which companies they have exposure to. With XTBs, investors can choose from bonds issued by some of Australia’s most trusted and well-known companies.
The importance of a maturity date
Like their underlying bonds, each XTB has a fixed maturity date, which matches that of the underlying bond. This maturity date, coupled with a known coupon amount enables an investor to determine the yield to maturity BEFORE they invest. It also means investors know how much capital will be repaid when the bond matures (subject to no default).
Pooled investments remove some of the predictability of fixed income
In contrast, ETFs and bond funds cannot provide this same level of predictability. Being perpetual, they don’t have a maturity date, leaving the investor unable to discern the yield to maturity. Because they are pooled investments, the bonds they hold can constantly change. This can make tracking what you are exposed to harder.
As a result bond fund and bond ETF investors are unaware of three key things:
- How much the fund is likely to be worth at a future date
- What the yield to maturity will be BEFORE they invest
- Which bonds the fund or ETF will hold in the future. This is particularly important for investors who want to avoid specific sectors or companies.
Sequencing risk and impact on returns
Financial outcomes can be dramatically different depending on when an investment is bought and sold. Buying shares at the bottom of a bear market means investors are likely to see prices increase as the market recovers.
The opposite is generally true when buying at the top end of a bull market. But how do you know where the top and the bottom is? Only in hindsight are these peaks and troughs revealed. The risk of poor performance experienced through buying or selling an investment at the wrong time is known as ‘sequencing risk’.
The importance of sequencing risk for retirees
Sequencing risk is of particular concern to those approaching or in retirement. In this phase of life the sequence of returns can have a pronounced impact on the sustainability of retirement income. A large negative return at this crucial time of life can greatly eat away at savings and affect an investor’s ability to make future investments.
Imagine the situation where you unexpectedly need to raise funds by selling an investment. In this scenario, share market investors are completely at the mercy of the market. They are left to guess when the optimum time to sell is. Bond investors, however, have the comfort of knowing how much their investment will be worth at maturity, absent of default.
The predictable bond coupon provides a regular and known income to help investors manage cash flows and expenditures.
Sequencing risk has taught us that as one nears and enters retirement, it is of the upmost importance that investments don’t take a big hit. Therefore, a portfolio weighted more towards defensive assets is crucial. A message repeated by the late John Bogle who coined the phrase that investors should “own their age in bonds”.
Term deposits, government bonds, corporate bonds and XTBs can all help to provide that defence. The predictability they can offer, particularly in uncertain times, is why bonds are often said to help you sleep at night.
This article was first published in March 2019 and updated August 2020