Retirees and other income investors, wanting to dial down their exposure to riskier assets within a rising interest rate environment, may wish to run their ruler over Sydney Airport 2030 inflation-linked bonds (ILF) and an ETF focused on floating rate securities: BetaShares QPON ETF.
Here’s a quick look at how they work:
These long-dated bonds start off with a $100 face value, and over time, with positive inflation, the face value grows. This effectively means your capital investment is indexed to inflation and this gets locked into your return, which comes in two parts.
The second part of your return comes from a fixed margin over the Consumer Price Index (CPI).
Within a rising interest rate environment - as all astute bond investors know - fixed rate bond prices fall.
It’s important to understand that while ILBs are linked to the CPI the fixed rate component underscores the falling in value in years to come.
Clearly, within an environment where interest rates are rising rapidly, there’s a corresponding need to re-set the value of the fixed margin to reflect an investor’s expectation of higher income.
While the price dropped from a March 2020 high of around $157 to just above $140, the point to note is that current yield plus CPI – which is now very likely to be higher for longer - is starting to look more compelling for income investors.
Given that the bonds have another eight years until maturity, the upside for a much higher capital value in a relatively short time from these types of investments looks worth considering.
While it’s anyone’s guess how high interest rate expectations [and the capital uplift] will go.
But suffice to say, based on their current trajectory, the price of the bonds will continue to fall.
However, bondholders can take some conform in knowing that Sydney Airport is higher quality investment now owned by a consortium of institutional investors with very deep pockets.
Within the current rising interest rate environment, floating rate securities like BetaShares Australian Senior Floating Rate Bond ETF (ASX:QPON) would typically be expected to perform well.
But, while the unit price has declined from around $25.90 to $25.51 year to date (- 0.86% return), some of this can be attributed to 0.22% in fees.
What’s also worth noting is the two recent significant redemptions to QPON to the tune of $82m.
Other drivers of a negative return were:
The ETF is strongly focus on 13 securities as at 17 May 2022.
Passively tracking the Solactive Australian Bank Senior Floating Rate Bond Index.
Having factored in higher margins on the back of higher interest rate expectations, new senior floating rate bond issues are being issued with higher margins.
Higher risk subordinated bank bonds can offer relatively better value.
Clearly, floating rate bonds [like all assets] are by no means immune to a fast and steep rise in interest rates.
Recent developments serve to remind investors that bond markets, despite appearances, are by no means dormant and that and prices and yields can be reset to reflect interest rate expectations in the blink of an eye.
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