HOW TO HAVE THE BEST OF BOTH WORLDS IN YOUR SMSF - INCOME AND SECURITY START

HOW TO HAVE THE BEST OF BOTH WORLDS IN YOUR SMSF - INCOME AND SECURITY START

1 2 3 4 5 CONTENTS CONTENTS 1 MEETING YOUR INVESTMENT GOALS...p.03 2 INVEST LIKE THE PROFESSIONALS...p.07 3 BOOST YOUR SMSF INCOME...p.12 4 WHY INVEST IN XTBs...p.19 5 SEE HOW XTBs CAN BENEFIT YOU...p.24 2

1. MEETING YOUR INVESTMENT GOALS

How to have the best of both worlds in your SMSF income and security Even in a low yield environment, there are plenty of income-generating assets available to investors. The real question is which ones to choose? Which can provide the income and capital security we re all looking for? With cash and term deposits currently offering investors extremely low returns, this question is more important than ever. In this e-book, we outline how many Australians are missing out on some of the most attractive yields and consider how SMSFs can generate higher levels of income, without significantly increasing their risk profile. 4

Let s start with your investment goals It s easy to get bogged down with technicalities, but it s important to keep your financial goals in mind: growing your wealth, whilst preserving capital. Income is important whether you re in the accumulation phase, or in retirement. While you re in the accumulation phase, incomegenerating components of your portfolio provide a solid, defensive base. As growth assets such as equity and property are volatile, a steady stream of income can help keep your portfolio on track. When you reach retirement it s income that funds your everyday spending. The cost of living is rising for us all. It s therefore critical that our investments are able to maintain or hopefully increase our purchasing power. FINANCIAL LIFE STAGES 5

Cash is king, right? Australian interest rates remain very low, pushing returns from cash and term deposits to the lowest levels on record. No matter where you look currently, you re unlikely to find a term deposit paying much more than 3% pa 1. If the rate is around 3% it will likely be for a longer dated term deposit, where your money is locked away. If you need to access your capital early, you risk losing some or all of the income. That s a rather disappointing return, especially considering the cost of healthcare, utilities and other everyday living expenses are increasing at a significantly quicker pace. Despite the security and certainty of income, allocations to cash and term deposits are currently well above what professional investors and advisers would recommend. And in spite of the extremely low returns on offer, some Australians are looking to increase their cash holdings further. For some, cash may still be king, but its crown has unquestionably lost some of its lustre. Surely it s possible for investors to make their savings work harder for them, without exposing them to unpalatable levels of risk? It s a little surprising, then, that more than a quarter of SMSF assets in Australia are held in cash and term deposits 2. It s understandable too. Of course, these assets offer the capital security that many investors are looking for. 1 Canstar.com.au Term Deposit Comparer $50,000 3-6 month best available term deposit rate 9 January 2017 2 As at 31 October 2016. Source: ATO 6

2. INVEST LIKE THE PROFESSIONALS

How the professionals are doing it Institutional investors face the same issues as SMSF investors. They re trying to find the right balance between security, income and capital growth for vast groups of investors, but the key question is the same, how can they make the assets they manage work the hardest for their investors? Institutional investors maintain a high level of diversification so their portfolios are not over-exposed to events that hit a particular asset class. Overleaf you can see the current breakdown of the flagship Balanced Option from AustralianSuper, Australia s largest superannuation provider 3, compared to the average current asset allocation of Australian SMSFs. 3 AustralianSuper Conservative Balanced Option as at 31 December 2016. Source: AustralianSuper 8

Figure 1: Typical institutional portfolio Figure 2: Average SMSF portfolio CASH & TDs 11.5% FIXED INCOME 1% OTHER 12% S 40.5% PROPERTY / INFRASTRUCTURE 16% S 32% PROPERTY/ INFRASTRUCTURE 14% CASH & TDs 25% FIXED INCOME 22% OTHER 26% The institutional investment mix is well diversified across the major asset classes as you might expect. When compared to the average current asset allocation of Australian SMSFs 4, as shown in Figure 2, you can see 4 As at 31 December 2016. Source: ATO that while both have significant investment in shares and comparable exposure to property/infrastructure, that s where the similarities end. 9

One of the two key differences between institutional and SMSF portfolios is their exposure to cash and term deposits. Given the extremely low returns on offer and their long-term investment horizons, most institutional investors have modest cash and term deposit holdings. They account for just 4% of the AustralianSuper Balanced Option, for example, compared to 25% for the average SMSF investor 5. Institutions typically hold cash for two reasons; 1. to be able to exploit investment opportunities as and when they arise; and 2. for operational purposes for example, funding redemptions and until regular superannuation contributions are invested in other asset classes. Cash and term deposits are rarely considered as an investment component that institutional investors expect to make a meaningful return to their overall portfolios. The other striking difference between institutional and SMSF portfolios is their exposure to fixed income securities, or bonds. Bonds If a government, state government or company wants to borrow money for a number of years it has two options; borrow from a bank, or issue bonds. Bonds are essentially IOUs that: 1. Pay back the loan (known as the principal or face value) when the bond matures 2. Deliver steady income streams, paid semi-annually or quarterly throughout the life of the bond, known as the coupon. 5 As at 31 October 2016. Source: ATO 10

Bonds account for a reasonable component of most institutional funds; 22% in the typical institutional portfolio shown on page 9. Very few SMSF investors have similar exposures to bonds. Bonds account for just 1% of assets in the average SMSF account 6. Rather than holding excess levels of cash, institutional investors favour bonds for the defensive component of their portfolios. Most bonds are relatively low risk and, importantly, offer known income. Cash, TDs and bonds all provide a defensive anchor to a portfolio; institutions choose to pick up the extra yield available from bonds and thereby improve the overall return from their portfolios. just as private investors need to match their income streams with their everyday expenditure. Cash and Bonds: The defensive anchors of a portfolio 0% CASH RISK LEVEL PRICE STABILITY BONDS (fixed & floating) RISK LEVEL PRICE STABILITY The known cash flow from bond coupons also enables institutions to match their income streams with known liabilities (pension payments to superannuation fund members), DEFENSIVE TO EQUITIES DEFENSIVE TO EQUITIES 6 As at 31 October 2016. Source: ATO Source: Australian Corporate Bond Company & Bloomberg 11

3. BOOST YOUR SMSF INCOME

Why are SMSF investors not considering bonds? Given their low risk profile and certainty of income, it s surprising that SMSF investors are not utilising bonds more extensively in their portfolios. It s unlikely this is because investors are unwilling to assume any investment risk. After all, most types of bonds are far less volatile than shares, which account for over a third of the average SMSF balance. Instead, the reason few SMSFs have meaningful exposure to bonds might have more to do with a perceived difficulty of accessing bond markets, or lack of understanding of the asset class. With minimum investment sizes as high as $500,000, direct access to bonds has historically only been available to those with very large investment portfolios. For others, it has only really been possible to access bond markets through managed funds. Most large investment management firms offer an array of unit trusts that invest in bonds. However bond funds and ETFs have one key drawback, they are perpetual investments. Perpetual investments cannot deliver a defined investment outcome, a key feature of fixed income. Indeed, the ability to have greater control over their investments in a cost-aware manner is why increasing numbers of Australians are moving away from the superannuation fund structure and establishing their own SMSF. 13

How bonds can boost the income generation of an SMSF Corporate bonds typically offer higher interest rates than cash and term deposits. This suggests SMSFs may be able to improve their performance, by reducing their cash balance and reallocating the proceeds into bonds. Thankfully, recent innovations mean it is now possible to access returns from bonds as easily as it is to buy and sell shares. payments (the face value of the bond paid back by the issuer when the bond matures) that they would have received had they invested directly in the bond itself. Exchange-traded bond units allow everybody to invest in this underappreciated asset class and enable SMSF investors to access the attractive income that is available. Exchange-traded bond units can be bought on the ASX by investors, just like they would buy shares in a listed company. Investors receive the same coupons (the regular income paid by the bond issuer) and principal 14

Exchange-traded bond units, or XTBs for short, are becoming increasingly popular due to their simplicity, affordability and convenience. Because they are traded on ASX, investors can easily monitor the value of their investment, as they do with their share portfolios. XTBs can be traded in large or small parcel sizes making them available to all investors, not just those with very large balances. With each XTB priced from $100 to around $120, incorporating corporate bond returns into your portfolio has never been easier. And, being exchange-traded means they can be bought and sold at any time, providing investors with liquidity and flexibility. This is not the case with term deposits, which tie up capital for a specified period and provide no flexibility if circumstances change due to unforeseen events. = XCHANGE TRADED BOND UNITS 15

What types of bond returns are available on ASX? Government bonds and corporate bonds are two of the most common types of fixed income security. XTBs focus on corporate bonds, meaning investors can access them easily, conveniently and affordably. Government bonds are among the safest investments available. This is indeed the case in Australia, where a combination of economic strength and a stable regulatory environment means investments in Australian government bonds carry very low risk. Investors feel assured that the government will be able to honour its commitment to pay regular bond coupons, as well as the principal upon maturity. Access to government bonds is available on ASX via AGBs. However, Australian government bond yields are currently lower than term deposit rates. GOVERNMENT BONDS VS. CORPORATE BONDS 16

Corporate bonds are issued by companies rather than governments, but work generally in the same way. The company is legally obliged to make regular coupon payments to investors, and to repay the principal in full when the bond matures. The key consideration for investors is therefore the ability of the company to fulfil these obligations. Much like investing in shares, only those investors with greater risk appetites would consider buying a bond issued by a fledgling company in an emerging economy, for example. Yield XTBs providing an average of 4.1% 7. This represents a 46% increase on the 2.8% returns offered by the best available term deposit 8. XTB PORTFOLIO: HIGH YIELD 46% INCREASE But what about bonds issued by large, successful corporations in developed and stable countries like Australia? Many of these companies are very stable and creditworthy, with their corporate bonds offering higher yields than similar-term government bonds, and generally above cash and term deposits as well. The yields from XTBs were up to 5.2% 7, with a Starter Pack of 5 High BANK: TERM DEPOSIT 7 Australian Corporate Bond Company. 9 January 2017 8 Canstar.com.au Term Deposit Comparer $50,000 3-6 month best available term deposit rate 9 January 2017 17

Introducing Exchange-Traded Corporate Bond units: XTBs Exchange-traded corporate bond returns in Australia are available via XTBs, which are traded on ASX. Unlike a term deposit, where investors are unable to readily access their savings, investors can easily buy and sell XTBs at any time, providing the flexibility and control that most SMSF investors are looking for. Some of the largest and most recognisable Australian brands The corporate bonds XTBs cover are issued by some of Australia s biggest and most recognisable brands. 18

4. WHY INVEST IN XTBs?

Scratching beneath the surface of an XTB With XTBs offering attractive income, combined with the flexibility of being easily traded on the ASX, it s surprising that more SMSF investors aren t reducing their cash and term deposit holdings and taking advantage of the additional income that is on offer. This may be due to a lack of awareness or understanding, so let s have a closer look at some of the other features and benefits of XTBs. Known, regular income: The amount and frequency of the coupons (the regular income paid to investors) of fixed-rate corporate bonds and XTBs are known. These are important benefits: known coupons can offer retirees a predictable, stable income in retirement, for example. Coupon payments are fixed for fixed-rate bonds. Issuers are obliged to pay them, regardless of movements in interest rates or other factors. This is an important differentiation from dividends that are paid by issuers of shares. Dividends are entirely discretionary and can fluctuate according to the profitability of a company. For floating-rate bonds the coupon rate is made up of a reference rate and an interest margin. The reference rate is a variable rate, such as the 3 month BBSW (Bank Bill Swap rate). The interest margin is a fixed amount above the reference rate. Issuers of both fixed and floating rate bonds are obliged to pay the coupon and they cannot defer the coupon, unlike some other floating rate instruments such as hybrids. 20

The key difference between a floating-rate bond and a fixed-rate bond is that the coupon will vary every three months for floating-rate bonds to reflect the level of the reference rate on the reset date. Another key difference is that floating rate bonds tend to pay coupons quarterly, whereas fixed rate bonds tend to pay coupons semi-annually. Select how often to receive income: While the coupon payment dates are known, frequencies can vary between XTBs; some pay quarterly and others semi-annually. It s possible to choose those that are right for you depending on how often you want to receive income. For example, choosing just three quarterly XTBs could allow you to build a portfolio that will provide a monthly income stream. Choose your level of income: It s also possible to choose XTBs to suit your individual income requirements and risk appetite. There are currently close to 50 XTBs to choose between, from a broad range of issuers. The wide choice offers a range of coupon frequencies and credit qualities, although all XTBs are issued by large and stable Australian companies, so the risks associated are relatively low. The yields available from each issuer will typically reflect the market s perceived level of investment risk. XTBs with the lowest level of perceived investment risk will typically offer the least attractive yields, and vice versa. 21

Control how long you wish to invest: Different XTBs also have different maturities. Investors can choose which are right for them depending on their investment horizon. Those that are happy to tie up their capital for around five years, for example, could consider an issue maturing in 2021, or 2022. This affords investors a high level of control over their pension an important consideration for those that have elected to control their own savings through an SMSF. And remember, being exchange-traded means XTBs can easily be bought and sold at any time if circumstances change. Term deposits, or other less liquid investments such as property, are unable to provide the same level of flexibility. Diversify with an uncorrelated asset class: A further appeal of XTBs and bonds is that their performance has historically been largely uncorrelated with shares and property, making them a useful portfolio diversifier. The average SMSF shown in Figure 2 shows that many savers are heavily exposed to shares and property, meaning their retirement savings could be at risk if either of these asset classes experiences an extended period of underperformance. As the institutional asset allocation example in Figure 1 shows, a greater degree of diversification is desirable. 22

Summary of benefits of XTBs Stable investments that boost your income generation, with higher yields than comparable fixed income investments such as term deposits and government bonds. Ability to choose your level of income. XTBs are available from a wide range of successful Australian companies investors can select those with different credit qualities and yields, depending on their risk appetite. Access to your money at any time buy and sell on ASX. A wide range of bonds with different maturities are available to suit the individual needs of investors. Receive known and reliable income, through regular coupon payments. Provide a useful diversifier to portfolios that are over-exposed to shares and property. 23

5. SEE HOW XTBs CAN BENEFIT YOU

Could XTBs be right for you? An investment in XTBs could provide you with greater control over the defensive component of your SMSF and enable your savings to generate a higher level of income to support current or future expenditure. With cash rates at historic lows and likely to remain subdued for the foreseeable future it is more important than ever to make your investments work harder for you. An investment in XTBs might be the answer. As with any investment, it s important to understand the risks involved. It s therefore recommended you seek your own professional advice, to see whether XTBs might be suitable for you. Build a portfolio of XTBs to see exactly what income you could receive Our online Cash Flow Tool lets you pick up to 10 XTBs and chart the income you would receive year to year, and over the lifetime of your chosen bonds, allowing you to compare XTBs to your existing assets. To help make that first step even easier, we ve put together three Starter Packs for you to choose from: High Yield, Top Brands or Cash Plus. Click below to build your portfolio and see how XTBs can help you achieve your investment goals. BUILD YOUR PORTFOLIO Alternatively, If you would like to be referred to a broker or financial adviser, or want any further information about the range of XTBs that are available, do not hesitate to contact us on 1800 995 993 where a member of our expert team will be ready to assist you. 25

Disclaimer Australian Corporate Bond Company Ltd (ABN 34 169 442 657, Authorised Representative No.: 469037) ( ACBC ) is an Authorised Representative of Theta Asset Management Ltd (ABN 37 071 807 684, AFSL No.: 230920) ( Theta ). Theta is the Responsible Entity of the Australian Corporate Bond Trust and the issuer of the Exchange Traded Bond Units ( XTBs ). ACBC is the Securities Manager of the XTBs. ACBC and Theta will earn fees for making the XTBs available to investors, which is payable at the time that an Authorised Participant applies for an XTB. An application has been made to ASX for the XTBs to be quoted on ASX pursuant to the AQUA Rules. Further a Product Disclosure Statement dated 2 January has been lodged with ASIC (the PDS ). No units will be issued until such time as ASIC and ASX have approved XTBs for admission to quotation. Applications will only be accepted from Authorised Participants pursuant to the PDS. All other investors must acquire XTBs on ASX or through an Authorised Participant. ACBC is solely responsible for the contents of this ebook. The contents of the PDS and this ebook are subject to change and ACBC makes no warranty, express or implied, as to the completeness of any statement contained herein nor does it represent that this presentation contains all of the information that an investor may require in order to assess the merits of an investment in XTBs. The distribution of this ebook or any other material relating to XTBs, including the PDS, to persons outside of Australia may be restricted by law and any person who comes into possession of such documents should seek their own advice on, and observe any such restrictions. The information contained in this ebook is general in nature and does not take into account any particular investors personal circumstances, objectives or needs. It is not personal financial product advice. You should read the PDS and consider, with or without the assistance of your professional advisers, whether an investment in XTBs is appropriate, having regard to your own personal circumstances. XTB is a registered trade mark of Global Bond Exchange Pty Ltd, a related body corporate of Australian Corporate Bond Company Limited. ABN 34 169 442 657. All rights reserved 2017 26