The return achieved on fixed income investments during FY21 was higher than many clients expected. Bonds are generally regarded as a conservative investment for those looking to invest in a more defensive asset. The returns achieved by FIIG investors over FY21 have shown that low risk does not always mean low return.
Background
Investors often invest in bonds when they are seeking a more stable, predictable income and have a lower risk tolerance compared to other asset classes. Investors typically make their bond selection based on their risk preferences and return target. However bonds also provide trading opportunities, where returns can be improved, such as when a bond’s price has increased and there is an opportunity to take capital gains.
A year in review – The recovery
FY21 was one during which financial markets recovered from the initial sell-off at the height of the COVID-19 pandemic. The bond market reflected this recovery and growing confidence. We saw the majority of bond prices recover and company performance improve. Sectors which are experiencing ongoing impacts from the pandemic continue to be priced below their pre-pandemic levels, but have recovered much of their initial price movement.
In the latter half of the year as prices increased, the yield to maturity (YTM) reduced for new investors. The recovery was not simultaneous and uniform which produced opportunities for investors to realise price increases and reinvest in bonds that had not fully recovered. Often called a relative value proposition, active clients were able to amplify their returns from the market recovery.
The chart below illustrates the recovery in high yield and non-rated bonds over 2020 (and continuing), following the sell-off caused by the pandemic.
Last financial year saw strong returns for bond holders on average across FIIG’s client base, with an average portfolio return of 7.74%. This is a significant result, also considering most bonds available to FIIG clients continued to pay a regular income throughout the height of the COVID-19 pandemic.
Companies are contractually obliged to make coupon payments to noteholders and repay capital on the bond’s maturity, allowing an investor to plan expenses around this. For all FIIG private client accounts (above AUD$100k):
- 75% of clients achieved a return of 5.49% or more
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25% of clients achieved a return of 9.41% or more
This is an attractive return given the defensive nature of fixed income compared to other asset classes. We look at an individual case study to further explore the returns that can be achieved through investing in a fixed income portfolio.
Case study
Diane and her husband have been a client of FIIG for 3 years, they are both retired and live off the income from their investments. Diane manages their fixed income portfolio, which is over $500k, and they decide how, when and where their self-managed super fund (SMSF) invests.
Diane likes the predictable income stream that bonds provide. As she points out, “You know when money is coming in so you can plan your life”. With short-term rates anchored due to monetary policies put in place by the Reserve Bank of Australia (RBA), Diane looked to bonds as a way to increase her investment options and overall return, as she commented “I’m able to invest in short term bonds to beat the cash rate”.
Diane and her husband work closely with her FIIG Relationship Manager to ensure she has the income she requires from her fixed income portfolio and that it offers a stable and predictable income stream. As Diane is in the retirement phase of her life, she would find it difficult to replace losses, and has chosen to enjoy lifestyle over closely monitoring equity markets. Bonds are considered to be a lower risk investment compared to other asset classes and as such Diane doesn’t worry about day-to-day price movements.
Diane chose to invest in bonds for her SMSF as she was looking for a “set and forget” investment. She doesn’t always have time to be managing her portfolio daily, or even every month, so it’s great to have an investment where she earns passive income. To that end, her portfolio is a diversified mixture of investment grade and high yield bonds. She has also included USD-denominated bonds to further diversify her income. The charts below show the rating and currency breakdown of Diane’s fixed income portfolio.
With that said, Diane realises that “if you want to make some money, you have to put in the effort”. She’s worked hard enough to build up her retirement savings, and now it’s time for her money to work hard and keep her and her husband comfortable. Adjusting her holdings regularly has kept her money working hard for them. In the last year she has taken advantage of a number of relative value opportunities and increased the return. The SMSF’s return for FY21 was 11.15%.
This is despite holding underperforming bonds like Virgin Airways (-48%) and a rally in the Australian dollar reducing the returns on the USD bond holdings (-8%). Outperforming bonds more than made up for these losses, with several FIIG originated bonds earning returns over 20%. For example, WA Stockwell earned a total return of 38.31% for the year. This demonstrates the importance of diversification within a portfolio and the importance of diversification across asset classes.
Diane’s fixed income portfolio return has not been hampered by her diversification strategy. By spreading her investment across multiple industries and bond types, she can spend less time looking at her investments and more time focusing on the important things in life.
Conclusion
A portfolio which includes high yield and investment grade bonds can provide strong returns and consistent cash flow. Investment grade bonds are issued by companies which are generally resilient to economic impacts and with strong track records. These type of bonds provide stability to a portfolio’s cash flow. Diane has a portfolio with a 37.98% holding of investment grade bonds, which managed a significant return of 11.15% after fees.
A Relationship Manager at FIIG Securities can assist to construct a diversified fixed income portfolio and identify opportunities to improve the overall return. These opportunities can come in many forms, and small adjustments to a portfolio can compound into improved returns.
*Past performance is not an indication of future performance