Part 6 of our 6 part fixed income educational series: Tools to build your corporate bond XTB portfolio
XTB Starter Packs
If you would like more help selecting XTBs there are a range of Starter Packs available. They have been developed to take the guess work out of building a portfolio of XTBs. Each Starter Pack has a defined investment strategy and approach. Each pack has been developed according to a range of quantitative rules.
Starter Packs currently available are:
Tracking the cash flows from your XTB portfolio
The XTB Cash Flow Tool is a handy and simple way to see the future cash flows of up to 10 XTBs. It visualises the coupon payments over time. It shows you when the principal from each XTB will be returned.
This can help you to plan your income needs versus your personal outgoings. Add or remove XTBs as you wish, until you have the cash flow you need, or the bonds you like.
Let’s look at the first portfolio we created, of the 8 fixed rate XTBs ranked by YTM and a total investment of $75,000.
The investment amount is split evenly between the XTBs, with a slightly lower allocation to YTMQF3 for a total investment amount just less than $75,000. The Cash Flow Tool automatically calculates the exact number of XTB units. This is based on the last closing price.
The tool charts all cash flows from these XTBs over the life of the investment. It shows the income and capital repayments you would receive year by year, or month by month.
The Cash Flow Tool lets you see your portfolio’s income year-by-year. In addtion you can see a 12-month view by clicking on any year on the x- axis. This feature allows you to check you have the income you need in set months. This could be for specific events such as school fees, holidays or just to ensure you have a regular pattern of income across the year.
TDs and both corporate and government bonds provide this high degree of future income and capital predictability. You can’t do this with shares because they don’t mature or have defined income. You can’t do this with diversified funds like ETFs or managed funds because you lose predictability as a result of the fund’s diversification and perpetual nature.
Remember: Fixed-rate XTBs provide greater predictability of income than the floating-rate XTBs because the coupon amount is known.
The Cash Flow Tool also provides a detailed table of the income split by each XTB and the face value or principal at maturity.
The final element is the Cash Flow summary of your portfolio. This shows an overview of cash out (your initial investment), plus all income and capital payments year-by-year.
The XTB Cash Flow Tool makes it easy to check that the portfolio you have selected will provide the income you are looking for. The tool allows you to email the results to yourself, and your financial adviser to use as the basis of a discussion, or simply to have as a record.
How to trade XTBs on ASX
Buying and selling XTBs is exactly the same as buying and selling shares, ETFs or any other ASX traded security. You can access the full range of XTBs via your financial adviser, broker, or online using your normal online broker account. There are no special accounts or payment methods to establish and your XTBs will appear alongside your equity and ETF holdings in CHESS.
If you do not own shares or ETFs, then opening a new online brokerage account is easy. As is becoming a client of a full service broker or financial adviser. The ASX website (www.asx.com.au) has a handy tool called ‘find a broker’, which allows you to select a broker to suit your circumstances.
With XTBs, there’s no minimum investment amount and there’s no additional paperwork required
Once you’ve used the Available XTBs table or the Cash Flow Tool to select the XTBs you’re interested in, it’s also important you read the relevant Product Disclosure Statement to ensure you understand both the benefits and the risks of an investment in XTBs and the corporate bonds to which they relate.
Measuring returns on bonds or XTBs
When you buy XTBs the price you pay corresponds to a ‘yield’, and if you hold to maturity that yield is your return. Our Yield Calculator converts prices to yields and vice versa for you. But what’s the yield if you sell before maturity? In this situation it’s very similar to shares. You know what you paid and when, the price you sold at and when, plus the income from coupons.
Some broker websites just focus on prices and they ignore income from dividends or coupons. For fixed income, the coupon is a large part of the total return. Not including the income makes no sense. Never look solely at XTB price differences when thinking about returns, as this underestimates how your investment has performed.
Another source of confusion is to look at the XTB price just after it has paid a coupon and think it has dropped in value. It has, but XTB prices rise as each coupon is accrued. They then fall on the day the XTB goes ex-Coupon. This is just like shares when they go ex-dividend.
Bond price charts have a saw-tool profile of coupons accruing daily in the price, then paying out, and then accruing the next coupon over the interest period. If your XTB looks like its dropped a few dollars in a short time, but absent bad news for the bond issuer or a dramatic rate hike by the RBA – it’s the XTB paying out a coupon to you.
Trading at a Premium to Face Value
A large proportion of Australian corporate and government fixed-rate bonds in May 2016 were trading well above their face values. The reason is – interest rates were at all-time lows in June 2016. Bonds issued in the past were issued when rates were much higher. Hence the cash flows associated with the older bonds is attributed a higher value by the market. Telstra issued a bond in 2010 with a 7.75% coupon when rates were 6-7%. Telstra is still paying 7.75% per $100 face value, now the bond/XTB prices are around $120. But you can’t expect to get 7.75% from Telstra when the cash rate is 1.75%. A market price around $120 brings the yield down to what you would expect for a bond/XTB from a company like Telstra – high 2s or low 3s.
Using Lend Lease as an example:
One of its XTBs was trading at $108.32 on 30 May 2016. It matures in four years at $100, meaning it’s going to lose $8.32 in capital value. So on price change alone, this looks like a poor investment. However, Lend Lease also pays 6% coupons each year. The total coupons have to be added to the capital loss to get the total return.
The table below shows a $100,000 investment in this XTB. Cash in, plus coupons and principal out over 2016 to 2020. Almost $100,000 paid in 2016, but only $92,300 back in 2020 shows the capital loss.
But $22,152 in coupons along the way means the total return is just over $14,400.
This return is 3.8% per annum – which is the Yield the XTB was trading at on 30 May 2016.
Investors in XTBs are buy and hold investors that buy XTBs for their yield and defensive traits. They are not expecting significant capital gains, which there won’t be.
Capital loss is a side feature of all government and corporate bonds when rates are lower now than they were when the bonds were issued. It can be offset against capital gains elsewhere in your portfolio, or carried forward.
Running Yield versus Yield to Maturity
Another good way to look at returns is to compare the Running Yield with the Yield to Maturity:
- The Lend Lease XTB receives coupons of 6% of face value, or $6 per XTB per year.
- You paid $108.32 to buy each XTB on 30 May 2016.
- Running Yield (similar to dividend yield) is the $6 coupon as a percentage of the XTB price. $6/$108.32 = 5.54%.
- You receive that running yield of 5.54% in coupons each year from 2016 to 2020 based on that purchase price.
- At maturity you have a capital loss of $8.32.
- The Yield to Maturity measure of total return takes the income at the running yield rate, plus the capital loss into account to show you your total return at maturity.
Remember: With XTBs you know these outcomes on the day you bought the XTB. This assumes there has not been a default.