Many stock market investors are at present very nervous about the state of the market. Many are increasing the percentage of cash held in their investment portfolios while others may have exited the stock market totally, selling their portfolios and holding 100% cash. Others are extremely nervous, with their charts warning of a possible market crash.
But if you do decide to exit what are you going to do with the cash? Interest rates for a 12-month term deposit are around 1.5% and falling rapidly. Many countries around the world, including Switzerland and Japan, already have negative interest rates. That is, you pay the bank for holding your money. Interest rates in America have been approaching zero although recently there was a minor upturn. 10 year bond yields in Australia recently dipped below 1% for the first time ever. Without claiming to be able to predict the future, it would appear that Australia is heading towards negative interest rates. How might one be able to benefit from this possible scenario?
A few facts about Treasury Bonds
Treasury Bonds are medium to long term debt securities issued by the Australian Government. They have a fixed annual rate of interest and are repayable at maturity. They are therefore similar to term deposits provided by Australian banks but are generally of longer duration. When issued, the minimum bid for purchase is $1,000,000, thus they are not available to the average investor.
Exchange-traded Treasury Bonds (eTBs) offer a convenient way for investors to invest in Australian Government Treasury Bonds. The holder of an eTB beneficially owns an interest in an Australian Government Bond in the form of a CHESS Depositary Interest (CDI). Exchange-traded Treasury bonds (eTBs) are quoted and traded on the Australian Stock Exchange (ASX) in the same way as equities (shares) and thus offer a readily accessible way to invest in the Bonds. eTBs can be regarded as tradeable term deposits.
There are 33 different Treasury Bonds which can be traded on the ASX. (Eight of the 33 are Indexed Bonds which adds a degree of complexity in assessing their value and they will not be considered in this article).
A sample of 4 of them is illustrated in the table below.
All bonds have a face value of $100 and you will receive that amount on their maturity date, irrespective of what you have paid for the bond. The coupon is the amount that you receive irrespective of what you have paid for the bond. For a coupon of 4.5%, you will be paid $2.25 twice a year, on a specified date, until maturity. The price is the current price for that bond. With interest rates believed to be going down, you will be paying more than $100 for all bonds.
That is, if you hold them to maturity you will make a capital loss, but you will have received a guaranteed income. The yield to maturity calculation takes into account both the capital loss and the income.
If you purchase GSBG33 at today’s price your return will be equivalent to almost 1% p.a. every year until 2033. This is obviously better than the negative return which may occur with a bank deposit in some or all of the years between now and then.
If interest rates continue to fall between now and say 2025 then investors will be willing to pay more than the present price for the bond. They might pay a price which would give them a yield of 0.5% instead of the present yield of 1.0%. Thus it is possible to make a capital gain with these bonds in addition to receiving a fixed, known, government-guaranteed income. Conversely, of course, if interest rates go up you may make a capital loss on the bonds if you purchase at present prices.
Sharesight
Sharesight is a share portfolio tracking system designed primarily for investors to keep track of their current portfolios and of the income and capital gains associated with their investments. It can also be used to create backdated hypothetical portfolios.
“There are 33 different Treasury Bonds which can be traded on the ASX”
Sharesight was used to create a hypothetical portfolio of 6 treasury bonds with a range of maturity dates and interest coupons. A parcel of $10,000 (including brokerage) for each bond was purchased on 13/3/2019 and the portfolio valued 6 months later on 13/9/2019. As each bond had been held for 6 months it received an interest payment equal to half the annual coupon rate.
Sharesight Treasury Bond Portfolio Report
It can be seen that the longer maturity bonds offer the greatest opportunity for capital gain.
Portfolio 6-month performance 13/3/2019 – 13/9/2019
This is an impressive performance over a short period of time but it must be emphasized that interest rates were falling (the RBA cash rate declined from 1.5% to 1.0%) during the period. A completely different performance (with perhaps a negative return) may well have been the case if interest rates had been rising.
Frank Shaw is an AIA member, he owns ASX listed Treasury Bonds