Investing in Australian government bonds

[LonerMatt]

Hi AB,

Must admit I found the bond component of the PP the most difficult to set up.

While I am not an expert on Bonds, the accountant advised:

1. In the PP the lower maturity bonds are sold and always replaced with higher maturity dates. Therefore as the bond allocation will always be roughly the same, interest will always be paid, hence always taxable.

2. The only Tax you have control over is the Capital Gains. So depending on when you sell, the tax can be minimized or a loss used to offset other capital gains.

I would be interested in your or others thoughts on how to hold the 50% bond allocation.  There could be a better way than how I have structured it.

Hal

Hal,

As 25% is cash and 25% is bonds, I'd divide these in to Short Term (cash) and Long Term (bonds).

That fulfills, essentially, the purpose of each.

Cash is available and liquid (relatively) - I'd be looking for 1-3 year bonds here, and buy at the highest rate possible each year.

There's also that protection against deflation.

I'm thinking the bond segment looks even easier than I thought.

I must admit, I don't know much about taxation, which usually just confuses me!

[AB]

As 25% is cash and 25% is bonds, I'd divide these in to Short Term (cash) and Long Term (bonds).

I think the problem with this is that our longest term government bonds are only 15 years and that's not enough to provide the interest rate volatility that's required by the PP.  Hence the suggestion for 50% intermediate bonds (still trying to figure out exactly what that means, but around 10yrs seems to be consensus) rather than 25% cash and 25% long-term bonds.

If only we had a properly developed government debt market!

[LonerMatt]

As 25% is cash and 25% is bonds, I'd divide these in to Short Term (cash) and Long Term (bonds).

I think the problem with this is that our longest term government bonds are only 15 years and that's not enough to provide the interest rate volatility that's required by the PP.  Hence the suggestion for 50% intermediate bonds (still trying to figure out exactly what that means, but around 10yrs seems to be consensus) rather than 25% cash and 25% long-term bonds.

If only we had a properly developed government debt market!

There are 20 year bonds.

HB never wanted people to hold until maturity, and I think a 15-20 year bond provides plenty of help against deflation. At least in the historical circumstance we have to examine (with the exception of Japan, maybe).

We all have our little variations. I like to keep things separate with the PP: different units for different purposes. Having 50% of the same thing for two different reasons seems counter intuitive to the philosophy of the PP: surely a compromise between two components can't provide what each separately was intended to?

[AB]

There are 20 year bonds.

But only capital indexed ones, not fixed coupon though?

The longest fixed coupon I can find is TB136 / 4.75% / 21 Apr 27.

The longest indexed is CAIN408 / 2.50% / 20 Sep 30.

[LonerMatt]

As always, Clive leaves with something interesting to consider.

35% SCV?

[AB]

Just one thing to add for any Australian readers wondering about the tax implications of capital gains resulting from selling bonds at a profit (e.g. possibility of 50% discount if held for more than 12 months).

I've discussed this with my accountant who has confirmed that any profits are treated as income, not capital gains, and are therefore taxed at the full marginal rate.

[Hal]

Hi AB,

Thanks for the update on the Capital Gains Tax. Looks like the law has changed, however from the ATO link it appears you can still claim some Capital Losses.

http://www.ato.gov.au/individuals/conte ... tm&page=26

While the rules apply to company bonds, I could not find any information on government bonds. Must ask the accountant next time I see him.

Hal

[AB]

Interesting link Hal, i would have assumed that you couldn't claim a loss so that's good news (assuming that making a loss is ever good news).  Seems that is not a capital loss though but rather some other tax deduction.  I guess that's more flexible because it can be claimed against ordinary income, not just capital gains?

"If you sell a company bond to someone else before the company repays the money it borrowed and you make a loss, in most instances you can claim a deduction equal to that loss on your tax return (supplementary section) at Item D15 Other deductions. It is not usually treated as a capital loss."

Will also try to find out more details from my accountant.

[AB]

It looks like Australia is finally getting fixed-income ETFs with two Australian Government bond funds now available (and I'd expect Vanguard to enter the market in the next couple of months).

iShares UBS Treasury (IGB) / 0.26% costs / http://au.ishares.com/fund/fund-overview-IGB-ASX.do
RGB Russell Australian Government Bond ETF (RGB) / 0.24% costs / http://www.russell.com/AU/exchange-trad ... ducts/RGB/

More information is at http://afr.com/p/personal_finance/smart ... BDT5v79bpL

I'll still be sticking with owning the bonds directly for the moment but this is certainly a welcome development, particularly given the ancient paper-based method of buying and selling bonds directly with our Reserve Bank.

[LonerMatt]

Thanks Hal!

Really interesting stuff there.

So, now, we can basically we can set up a low cost ETF PP here too!

[Exocet]

The recently launched bond ETFs in Australia are quite illiquid at the moment, which means that they have very wide buy/sell spread.  They'll be an ideal product in times to come, but not now.

Another recent development is the launch of the Vanguard Inflation Linked Govt Bond fund.  Although the "inflation linked" concept is not ideal, at least thebond has a relatively longer duration (8.5 years) compared to other bond funds around.  A 50% allocation to this one, instead of 25% cash + 25% LT bonds, makes perfect sense to me.