Opinion – XTBs to usurp TDs’ income crown

13-Oct-2017

By Richard Murphy

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While many Australians have taken advantage of the prolonged period of low interest rates, the party has been one-sided.

Those reliant on income from term deposits (TDs) have had little cause to celebrate.

Although the official cash rate has remained at 1.5 per cent since August 2016, term deposit rates have continued to slide. One could argue that cash is no longer king.

Reserve Bank of Australia data reveals subdued TD rates of as low as 1.95 per cent for a three to six month deposit. Given a current inflation rate of 1.9 per cent once tax is paid on the income received, it would barely keep pace with inflation.

In real terms, each dollar of income received would be worth less than when it was invested.

Despite this disappointing outcome, Australian investors continue to rely on term deposits. According to Australian Prudential Regulation Authority data, Australian households had more than $850 billion on deposit at 31 July this year.

In this environment, how can financial advisers source income for clients from defensive assets rather than from higher risk assets such as equities or hybrids?

One option is to look at corporate bonds. An investor in a corporate bond makes a loan to a company and, in exchange, receives regular interest payments at designated times.

When the bond matures, the investor receives the face value of the bond.

Traditionally the domain of institutional or sophisticated investors, until recently retail investors could only access corporate bonds through a managed fund or exchange traded fund.

Investors and financial advisers could not pick and choose corporate bonds in the same way they could select shares in those same companies.

Exchange traded bond units (XTBs) make corporate bonds accessible to all investors. XTBs are securities traded on the ASX that bring together the predictable income from corporate bonds, with the transparency and liquidity of the ASX market.

XTBs provide investors with exposure to a specific underlying corporate bond of an ASX100 company, such as Telstra, NAB or BHP. The performance of each XTB closely follows their individual bond counterpart in the wholesale market.

Each XTB has the same maturity date and coupon payment frequency as its corporate bond – a three year corporate bond with a coupon of 5 per cent translates to a three year XTB with a coupon of 5 per cent.

Importantly, XTB investors receive 100 per cent of coupon payments as well as the face value of the bond at maturity.

XTBs deliver the regular income payments associated with term deposits, but with superior returns.

Unlike term deposits, there are no penalties for selling out before the maturity date, nor a requirement for a large investment to get the best rates.

While there may be no government guarantee, corporate bonds sit just above TDs on the risk-return spectrum and have similar risk propositions as well as a similar payout profile; both involve a known amount being repaid on a set date, with fixed interest payments on fixed dates.

Whether investors seek diversification, income or an alternative to term deposits, corporate bonds are a worthwhile addition to an investment portfolio.

With more than 45 XTBs available across 29 ASX100 companies, advisers can easily create a diversified portfolio of XTBs or access existing model portfolios to meet clients’ investment and income objectives.

As well as providing capital stability and a predictable and regular income stream, the defensive nature of corporate bonds – and therefore XTBs – will generally result in low or negative correlation with equities.

 XTBs might therefore be the new king when it comes to income generation from defensive assets.

Richard Murphy is co-founder and chief executive of XTB

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