We receive many questions from advisers on the sensitivity of XTBs to rate changes. Over the next few weeks we will look at three of the main questions and analyse the impact of a number of yield changing scenarios on XTBs.
We often hear advisers and investors express their concerns that rates are at their lows. This concern is perhaps slightly more muted now than it was a year ago, particularly since the last rate cut and the ‘lower-for-longer’ mantra became more frequently quoted.
How sensitive is each fixed coupon XTB to a change in yield?
What’s driving this question from advisers is a concern that rates have reached their low point and so the next move could be up, which makes them hesitant to allocate to fixed-rate bonds. The accompanying analysis shows the returns from XTBs if their yields fall, stay the same or increase in yield. The results generally relieve some of advisers’ concerns and demonstrate the stability that XTBs can provide in any portfolio.
Estimating Total Returns
Given the nature of fixed income securities such as XTBs, it’s possible to calculate what the future Total Return of each XTB will be, assuming a Yield to Maturity at a future date. An XTB’s Total Return consists of the change in price plus any coupons received.
Important Note: A change in YTM only affects investors who sell their securities after the change. If held to maturity an investor will receive the YTM of the XTBs at time of purchase.
The table below calculates each fixed coupon XTB’s Total Return after one year, assuming three different yield scenarios.
Data as at 03 June 2016
- 30 of the 32 fixed coupon XTBs will still have a positive Total Return even if their YTMs increase by 1.00% and their prices fall
- Only 2 XTBs actually produce a negative return for the same increase in YTM. The worst return would be -0.45%.
As expected, all returns from the neutral YTM scenario are positive and returns will be even higher under the lower YTM scenario.
What causes a change in YTM?
The analysis above does not assume what causes the change in YTM. A number of factors can impact YTM, such as:
- An actual rate move by the RBA,
- An expectation of a move by the RBA,
- A change in the shape of the Yield curve, or
- A change in the credit perception, or actual rating of a specific issuer.
All of these factors and more, can affect the YTM of an XTB and the bond it covers.
The use of a 1.00% change in YTM was for example purposes only and not a forecast of outcomes. YTM movements can be greater or less than 1.00% and have the potential to move up or down based on a number of economic or issuer specific factors.
- XTBs are a capital stable security that can diversify and anchor a portfolio. XTBs they have regular and predictable income, subject only to no default by the bond issuer. Therefore XTBs provide a known investment outcome. This allows investors to accurately plan their known outgoings versus known income.
- Because they are available on ASX and have a Market Maker, clients can sell their XTBs and receive cash proceeds at T+2 (or use the proceeds to net settle an equity purchase if executed on the same day).
- It’s easy to build a portfolio of XTBs that have a positive Total Return after a year, even if the XTBs increased in YTM by 1.00%.
How to construct a portfolio based on your expectation of yield movements.