This article appeared in the March 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
How Exchange-traded Australian Government Bonds will work.
By Mike Saba, Evans & Partners
It's finally here. After years of waiting, and an obvious need, government bonds will soon be available for all investors on ASX. Exchange-traded Australian Government Bonds (AGBs) will trade alongside all ASX-quoted securities. They will enjoy the benefits of trading in small or large parcels, ease of settlement, and the efficiency and low cost of registration in CHESS.
This means that a current user of ASX will be able to simply buy and sell AGBs just as they can trade BHP Billiton or a Commonwealth Bank hybrid security. Their current broker account, associated settlement mechanisms and income direction instructions (for example, where dividends/coupons are paid) will apply.
(Editor's note: Learn about the features, benefits and risks of Exchange-traded AGBs investments by taking the free, online AGBs course) You can also watch a presentation by industry expert Steve Wright of RBS Morgans).
The benefits of Exchange-traded AGBs include:
- liquidity that comes from being exchange traded and supported by dedicated market makers
- transparency of pricing
- having equal access to the market
- the ease of trading through the ASX broker network; and
- the integration into broker portfolio management systems.
There are many reasons to invest in Exchange-traded AGBs, in particular:
- the ability to hold the highest quality investment
- to gain exposure to falling interest rates
- to be used as the backbone of a diversified portfolio or specific bond portfolio; and
- As an insurance mechanism to counterbalance more potentially volatile parts of a portfolio.
What are Exchange-traded AGBs?
Australian Government Bonds ("AGBs") are debt securities issued by the Australian Government. Exchange-traded AGBs are parallel instruments which offer a convenient and readily accessible way to invest in Australian Government Bonds.
The holder of an Exchange-traded AGB has beneficial ownership of an Australian Government Bond in the form of a CHESS Depository Interest ("CDI"). This means the holder obtains all the economic benefits (including payments) attached to legal ownership of the AGB over which the CDI has been issued.
Types of Exchange-traded AGBs
There are two different types of Exchange-traded AGBs:
Exchange-traded Treasury Bonds (TBs) are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security, payable every six months. Each bond has a face value of $100 although you transact at a price higher or lower than face value when trade on ASX. At the TB's maturity date, the bond's face value is repaid plus the final coupon.
Exchange-traded Treasury Indexed Bonds (TIBs) are a similar concept to a standard bond, but the face value is adjusted to movements in the Consumer Price Index (CPI). Interest is paid quarterly based on the adjusted face value and at the TIBs maturity date, the adjusted face vale of the bond is paid to the holder. In this way investors are protected from inflation diminishing their capital.
What will be quoted?
All existing benchmark Treasury Bonds (TBs) and Treasury Indexed Bonds (TIBs) that are traded in the wholesale market will be quoted as Exchange-traded AGBs. This means a total of 22 different bond series will be quoted with liquidity supported by three ASX appointed market makers.
Why invest in government bonds?
To achieve a diversified risk profile, investors should consider structuring their investment portfolio across a broad range of asset classes, which should include some weighting to bonds. Bonds typically provide steady, low-volatility returns. This is extremely important as retirement approaches or has already commenced. Weightings to bonds should increase as commencement of drawdown (in retirement savings) approaches. Holding a TIB provides protection from inflation, which is important for those needing to maintain their purchasing power over time.
As an alternative to a multi-asset portfolio, a very risk-averse investor may hold AGBs as a standalone investment or as part of a bond-only portfolio. There are now a variety of sub-asset classes of bonds to choose from - floating rate notes (typically issued by banks) other corporate bonds and now Exchange-traded AGBs.
Each bond, whether an AGB or corporate bond will have a different credit risk, coupon and maturity date. The rule is that the higher the risk, the higher the yield to maturity. As AGBs are the most credit worthy, you should expect that they will have the lowest yield to maturity.
Holding government bonds gives either a balanced or bond-specific portfolio backbone for risk-averse returns. Other asset types can be added to seek higher returns. In the case of a multi-asset balanced portfolio, this may be equities or property. In the case of a standalone bond portfolio, this may be higher-yielding corporate bonds. Any well-structured portfolio will have risk exposures spread (by holding different types of bonds with different maturities).
A holding in government bonds helps counterbalance riskier exposures. This is especially important in times of market volatility. We saw many times during and since the GFC how government bonds respond when risk or fear rises or a major negative event unfolds. Money moves into government bonds because they are the safest asset class and pay a return.
As interest rates fall, bond prices rise. This gives rise to the protective nature of government bonds. Rising bond prices under this scenario will offset a fall in other asset classes that are negatively impacted by the rise in market volatility.
In some sense, government bonds can be considered a form of portfolio insurance. They allow risk in other areas to be taken and still provide a return. It is hard to act after a risk event; prudent risk-averse portfolios hold government bond weightings in advance.
The yield on a government bond may look low in isolation, but a key factor is the consistency of return and the offsetting of other risks. Looking at overall returns from holding government bonds since 2000, it shows a picture of steady returns. Some of these returns have been driven by the steady decline in interest rates over this period.
About the author
Michael Saba has covered Australian hybrid securities for more than 20 years at a number of major Australian broking houses. He specialises in analysis and sales of Fixed Interest to institutional clients, and has regularly polled at the top of major Industry surveys. He is Head of Fixed Interest and Derivatives at Evans & Partners, which is a major participant in the ASX-listed bond and hybrid markets.
ASX Interest Rate Securities provides useful information for those who want to learn more about fixed-income products, such as:
- Corporate bonds
- Floating notes
- Convertible notes
- Hybrid debt securities.
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