Investing in Australian government bonds

[AB]

I've just spent the last day or two reading some of the many HBPP threads and I'd like to take my first step with the portfolio.  The problem I have is that I live in Australia and the Australian government doesn't issue 20 or 30 year bonds (our government debt market is very underdeveloped in general - you still need to buy and sell via physical mail and cheques).

The longest outstanding bond is due in April of 2027 (i.e. ~15 years).  I understand that this will give me less protection from deflation - is there anything I can do to mitigate this problem or should I just implement the portfolio as is?

Another question I have is when should I roll this over.  I guess as soon as another longer term bond is issued?

(And thanks for all the knowledgeable advice and postings from the regulars here and at Bogleheads...)

[clacy]

Personally, I would just allocate 50% to 10-yr treasuries or an intermediate bond fund, in lieu of cash and LTT's.

So 25% gold, 25% stocks, 50% intermediate treasuries will more or less give you similar protection to a 2x 25% STT/LTT split

[MediumTex]

Personally, I would just allocate 50% to 10-yr treasuries or an intermediate bond fund, in lieu of cash and LTT's.

So 25% gold, 25% stocks, 50% intermediate treasuries will more or less give you similar protection to a 2x 25% STT/LTT split

Yep, 50% 10 year bonds is the way to go.

[AB]

Thanks for the reply Clacy.  As far as I know, there are no Australian Government only bond funds available, so I'd have to buy the bonds directly.  If that was the case, when would I roll the bond(s) over.

The following are the outstanding Australian Government bonds - from http://www.rba.gov.au/fin-services/bond ... 6:27%20EST

Series Investor Purchases Investor Sales
Type No. Coupon Maturity Price Yield Price Yield
TB 123 5.75% 15 Apr 12 102.226 4.140 102.210 4.240
TB 127 4.75% 15 Nov 12 101.772 4.035 101.700 4.135
TB 118 6.50% 15 May 13 104.942 3.805 104.820 3.905
TB 129 5.50% 15 Dec 13 104.234 3.645 104.056 3.745
TB 125 6.25% 15 Jun 14 106.875 3.645 106.647 3.745
TB 131 4.50% 21 Oct 14 103.675 3.635 103.420 3.735
TB 119 6.25% 15 Apr 15 109.898 3.635 109.589 3.735
TB 134 4.75% 21 Oct 15 105.183 3.690 104.836 3.790
TB 130 4.75% 15 Jun 16 105.039 3.695 104.634 3.795
TB 120 6.00% 15 Feb 17 110.467 3.700 109.990 3.800
TB 135 4.25% 21 Jul 17 102.655 3.775 102.164 3.875
TB 132 5.50% 21 Jan 18 109.466 3.785 108.915 3.885
TB 122 5.25% 15 Mar 19 110.769 3.865 110.127 3.965
TB 126 4.50% 15 Apr 20 105.370 3.950 104.666 4.050
TB 124 5.75% 15 May 21 114.719 4.025 113.898 4.125
TB 128 5.75% 15 Jul 22 114.195 4.125 113.293 4.225
TB 133 5.50% 21 Apr 23 113.084 4.225 112.147 4.325
TB 136 4.75% 21 Apr 27 105.085 4.430 103.972 4.530

[AB]

Just doing a bit more research and it seems that most (US) intermediate bond funds hold bonds between 5-10 years to maturity.  So I should buy Australian bonds each time at 10 years to maturity and roll-over around 5 years to maturity?

[MediumTex]

Just doing a bit more research and it seems that most (US) intermediate bond funds hold bonds between 5-10 years to maturity.  So I should buy Australian bonds each time at 10 years to maturity and roll-over around 5 years to maturity?

I would start off with the premise that you should buy the longest dated bond that are available, which I guess would be 15 year bonds.  Intuitively, it seems like that might translate into something like 35% 15 year bonds and 15% "cash".

If you took this approach, you might plan to buy the 15 year when it is issued and roll it into a new 15 year bond when it gets to 10 years until maturity.

You might play around with those allocations a little and see what it looks like.

[LonerMatt]

AB

Welcome to the PP forums.

Might I suggest doing a search of my posts, there are quite a few that deal with implementation in Australia (I've not done it). Especially some of the threads Clive has been involved in are particuarly useful.

I've got a bunch of backtested spreadsheets for you if you're keen.

Problem! The selling of bonds here works much differently to the US, and I'm not sure exactly what they'd be sold for or how (they can be sold back to the RBA, but on to a private buyer I wouldn't be sure there's a reliable method to do that.)

[MediumTex]

AB

Welcome to the PP forums.

Might I suggest doing a search of my posts, there are quite a few that deal with implementation in Australia (I've not done it). Especially some of the threads Clive has been involved in are particuarly useful.

I've got a bunch of backtested spreadsheets for you if you're keen.

Problem! The selling of bonds here works much differently to the US, and I'm not sure exactly what they'd be sold for or how (they can be sold back to the RBA, but on to a private buyer I wouldn't be sure there's a reliable method to do that.)

If there isn't a highly liquid secondary market, how would an investor capture gains in the event of a fall in interest rates?

Are you saying that bonds basically have to be held until maturity?  If you are saying that the RBA will buy them back, will they pay the market price based upon the interest rate moves since they were purchased?

In general, what kind of secondary market is there for government bonds in Australia?

***

BTW, like many Americans I am fascinated by Australia and I picture Australians sitting around making witty comments and either drinking beer or planning their next beer drinking excursion more or less all of the time.  I'm sure life there is somewhat more complicated than that and probably does have its serious moments, but that just doesn't happen to be part of my Australian fantasy of laid back people petting koala bears, squelching reality with a clever phrase and creating lovely works of art like "The Castle."

[LonerMatt]

If there isn't a highly liquid secondary market, how would an investor capture gains in the event of a fall in interest rates?

Broadly speaking, I don't know. There's an Australian Vanguard Fund that deals in bonds, but it's a roudnabout way of doing things. Apart from industry contacts, it's tricky to find out how the secondary bond market works. We're free to sell for what we want, but it's not as simple as it seems from the States.

Are you saying that bonds basically have to be held until maturity?  If you are saying that the RBA will buy them back, will they pay the market price based upon the interest rate moves since they were purchased?

This is the information about selling:
http://www.rba.gov.au/fin-services/bond ... bonds.html

Essentially, this is written in vocabulary I don't understand. As far as I can tell (and please correct me if I'm wrong) the RBA will buy the bonds back minus the interest (essentially I lose no money). This could be a good way of wheeling and dealing in the profitability, but is also much less flexible than what's available in the US (quarterly price revisions).

In general, what kind of secondary market is there for government bonds in Australia?

I wish I could answer this, but the information is so non-existent it's impossible for me to know. Broadly, larger institutions trade and sell bonds (between themselves and each other), but for little guys like me, no one's going to bother buying $5000 of bonds off me. The government might buy them back (as above) but at what rate, I don't know. Certainly the capital is preserved and the interest paid isn't taken back, so as far as I can see, for me, the option is basically to upgrade to a higher interest rate. If possible.

However, as Clive has pointed out, the PP has pretty tenuous results compared to just STT. While that's not super applicable here, Australian PP investors (well one or two that I have talked to) reported about 5% growth last year. Just in Government Bonds (which are still AAA+++++++++ here and our government has nearly no debt) would have yielded 6.5% minimum.

BTW, like many Americans I am fascinated by Australia and I picture Australians sitting around making witty comments and either drinking beer or planning their next beer drinking excursion more or less all of the time.  I'm sure life there is somewhat more complicated than that and probably does have its serious moments, but that just doesn't happen to be part of my Australian fantasy of laid back people petting koala bears, squelching reality with a clever phrase and creating lovely works of art like "The Castle."

Well, I don't drink alcohol, but generally people are laid back. It's very ethnically and culturally diverse, and I do have a lot of enjoyment of my little country. There are a lot of formative issues, and more so than many places Australia is still trying to find who and what we are. I love to ramble on about this place, so if you've got direct questions ask them, please!

[AB]

Thanks for your comments.

LonerMatt, I sent you a private message after coming across one of the threads you started.

The Reserve Bank of Australia both sells and buys bonds in denominations of $1000.  They charge an administration fee of $2.50 per $1000 face value for each transaction and the spread are listed in my post above (seems to be consistently .1% of yield).  My understanding is that RBA will buy them back for at any time for the sell price which is calculated based on the YTM and you don't lose any interest payments (e.g. they operate like any other buyer would).  It's all paper based though - you have to write them a cheque and mail it to them if you don't live close buy in either Sydney or Canberra.

We definitely have an underdeveloped market for government (and corporate) debt here in Australia.  I'm hopeful that there will be some bond ETFs listed this year after our stock exchange finally approved them.  I've read that Vanguard is working on some now.

[LonerMatt]

Thanks for your comments.

LonerMatt, I sent you a private message after coming across one of the threads you started.

The Reserve Bank of Australia both sells and buys bonds in denominations of $1000.  They charge an administration fee of $2.50 per $1000 face value for each transaction and the spread are listed in my post above (seems to be consistently .1% of yield).  My understanding is that RBA will buy them back for at any time for the sell price which is calculated based on the YTM and you don't lose any interest payments (e.g. they operate like any other buyer would).  It's all paper based though - you have to write them a cheque and mail it to them if you don't live close buy in either Sydney or Canberra.

We definitely have an underdeveloped market for government (and corporate) debt here in Australia.  I'm hopeful that there will be some bond ETFs listed this year after our stock exchange finally approved them.  I've read that Vanguard is working on some now.

Exactly, which just means those massive gains people report on bonds in the US probably won't happen here at all. That's fine, a steady solid gain can be excepted, or protection from deflation.

Personally I'd buy a basket of bonds: not just the longest, but some of the 10-15 year bonds offer great prices too, and can easily be rolled over (the lack of 5 years is worth the extra 2% IMO.)

[AB]

MediumTex, funny you mention The Castle (a great film in my opinion) as we're lucky enough to be enjoying one of the few remaining great housing bubbles in the world, and Down Under, a man's home is still certainly his castle (and in a lot of people's eyes, you're not really a man if you only rent one castle from the bank).

Australian's do generally have a good sense of humour (we spell British-style thank-you-very-much) and can be pretty good fun if you managed to stop us talking about our property investments and middle class welfare entitlements.  We certainly do drink our fair share of beer!

BTW, you and CraigR are the two people I need to thank most for opening my eyes to the HBPP.

[MediumTex]

Well, I don't drink alcohol, but generally people are laid back. It's very ethnically and culturally diverse, and I do have a lot of enjoyment of my little country. There are a lot of formative issues, and more so than many places Australia is still trying to find who and what we are. I love to ramble on about this place, so if you've got direct questions ask them, please!

I live in Texas, so I would imagine I could substitute "Texas" for "Australia" and answer many of my own questions.

I would probably also need to substitute "cowboy hat" for "beer", though there is a lot of beer consumed in Texas.

I have noticed that an Australian in Texas always seems to be the center of attention.  I think that Texans often feel that Australia is what might happen if Britain and Texas got together and made a country.

It would probably bring a smile to your face to know that all many Americans know of Australia is what they learned from watching the "Crocodile Dundee" movies and "Priscilla, Queen of the Desert."

As for me, I have a bit more sophisticated understanding.  In addition to the movies above, I have also watched the "Mad Max" films. 

[LonerMatt]

Well, I don't drink alcohol, but generally people are laid back. It's very ethnically and culturally diverse, and I do have a lot of enjoyment of my little country. There are a lot of formative issues, and more so than many places Australia is still trying to find who and what we are. I love to ramble on about this place, so if you've got direct questions ask them, please!

I live in Texas, so I would imagine I could substitute "Texas" for "Australia" and answer many of my own questions.

I would probably also need to substitute "cowboy hat" for "beer", though there is a lot of beer consumed in Texas.

I have noticed that an Australian in Texas always seems to be the center of attention.  I think that Texans often feel that Australia is what might happen if Britain and Texas got together and made a country.

It would probably bring a smile to your face to know that all many Americans know of Australia is what they learned from watching the "Crocodile Dundee" movies and "Priscilla, Queen of the Desert."

As for me, I have a bit more sophisticated understanding.  In addition to the movies above, I have also watched the "Mad Max" films.   :D

Mix England, Asia, a bit of the US and a bunch of swagger and you've got Australia.

We're a hodge podge of everything and I wouldn't have it any other way.

[Hal]

Hi AB,

As another PP'r from Australia, I thought I would share with you my approach to the Bonds

Have a 50% allocation using a ten year bond ladder. See Clives earlier helpful advice for further details.
When I started this, the 10 year bonds were the longest duration, but its interesting to note that 15 year durations are now available.

Would be interested to know what Index Fund you are planning to use for the shares. Using the SPDR ASX200 myself.

Hope this is of some help

Hal

PS: MediumTex,  Have to like the sense of humour of some of the institutions down here. Where else would you find this on an official website

http://australianmuseum.net.au/Drop-Bear

And you thought Koalas were cute and cuddly....

[LonerMatt]

Hi AB,

As another PP'r from Australia, I thought I would share with you my approach to the Bonds

Have a 50% allocation using a ten year bond ladder. See Clives earlier helpful advice for further details.
When I started this, the 10 year bonds were the longest duration, but its interesting to note that 15 year durations are now available.

Would be interested to know what Index Fund you are planning to use for the shares. Using the SPDR ASX200 myself.

Hope this is of some help

Hal

PS: MediumTex,  Have to like the sense of humour of some of the institutions down here. Where else would you find this on an official website

http://australianmuseum.net.au/Drop-Bear

And you thought Koalas were cute and cuddly....

What are your figures like Hal?

[MediumTex]

I guess for the Aussies it's not the middle of the night right now.

Forgive me for the digression, but I would like to provide another example of why I think Australians are the coolest people in the world.  The link below is to a 28 second clip of an Australian car race that had a kangaroo jump onto the track and weave in and out of the cars for a bit (the kangaroo appears not to have been injured).  What was really remarkable to me was the way the announcers appeared to be only mildly surprised at what was happening.  They talked about the kangaroo the way they might have talked about a particularly tight turn.

http://www.youtube.com/watch?v=nsBL51yj ... re=channel

[AB]

Thanks all for your helpful responses.

Hal, I'm looking at Vanguard's Australian Shares Index ETF for the stock component.  (http://www.vanguard.com.au/personal_inv ... ex-etf.cfm)  ASX code VAS and expenses of .15%.  Will probably also add a small slice of VTS and VEU (US and world ex-US).

I already have roughly 25% of physical gold purchased a few years ago, so that's no problem and will be looking to buy 50% of the Australian Government 10yr bonds over the next couple of days.  Unfortunately it's all paper and postal mail based so it takes a while to organise.

LonerMatt, thanks for the emails and spreadsheets - I appreciate the information you're sent through as well as the private discussions.

MediumTex, I've read many of your comments here and on Bogleheads and I find myself agreeing with the majority of your thoughts, particularly when it comes to complete ignorance of what the future may hold (in a positive way!)  One of my revelations has been that I'm not comfortable with as much risk as I used to think I was, but even more importantly my earning capacity is pretty good so I don't even need to take the risk (Fail-Safe rule #1).

Clive, one of LM's spreadsheets had Clive in the filename which I assume is you, so thanks for your thoughts and calculations as well.

As for the comments on Australia - yes, it's definitely a nice place to live though we have a high cost of living.  I've travelled through many parts of the US and Europe and a few parts of Asia and I am always happy to come home.  Very much The Castle at the moment (with a heap of mining added) but we may turn in to Mad Max if and when our housing bubble bursts and we're stuck with our massive private debt after our assets deflate.  Luckily we have relatively small amounts of government debt, but being a pessimist, we're not far off where Ireland was before she nationalised her banks' debt.

We certainly do have to worry about the Drop Bears Down Under, but also the Hoop Snakes which are less well-known but just as deadly.

[AB]

Sorry Hal, meant to ask.  When you talk about the 10yr bond ladder, do you mean buying a 10yr and then selling it at 9yrs and buying another 10yr?  And is that the only time that you rebalance bonds if necessary?

[MediumTex]

MediumTex, I've read many of your comments here and on Bogleheads and I find myself agreeing with the majority of your thoughts, particularly when it comes to complete ignorance of what the future may hold (in a positive way!)  One of my revelations has been that I'm not comfortable with as much risk as I used to think I was, but even more importantly my earning capacity is pretty good so I don't even need to take the risk (Fail-Safe rule #1).

I think that one of the reasons so many investors don't do very well over time is because they are investing in a way that is completely out of step with their true risk tolerance.

Taking more risk than you are really comfortable with can be a recipe for misery--you become sort of permanently nervous about the markets, you second guess every decision you make and your emotions take over at the worst possible times. 

I have noticed that this is a topic no one on Wall Street ever seems to want to touch.  I think the idea that different investors who are otherwise identical should invest differently simply because of their different psychological make-ups would strike many investment advisors as crazy, even though it is the same sort of logic that leads one person to drive a family sedan and another person to drive a sports car.

I think that risk tolerance should be determined by getting to know yourself rather than something like age or years to retirement.  I don't foresee myself getting more conservative in my investments as I grow older, and if I knew when I was 20 what I know today I would have happily started off with the PP when I first started investing.  I really wish there was more written on this topic, because I think the whole "take risk when you are young and get conservative when you are old" narrative isn't really a very good fit with the way many people actually perceive and react to risk.

[Hal]

Hi AB,

With regards to your question on the bond ladder.

The plan at the moment is to have a series of bonds from 1 to 10 years. As each matures, then it is to be reinvested as a "new" 10 year bond. My accountant advised that if I sell before the maturity date, then capital gains tax could be an issue (highest rate can be 45% depending on your income!). If I hit the upper rebalancing band, then will sell the bonds that will be taxed the lowest.

The way you set up the PP will depend on the investments available and the local tax laws. Now that longer term bonds are available, the ladder could be pushed out to 15 years.

Hal

PS: Lonermatt. Don't have the exact figures as the PP has been going for less than a year, but I estimate it to be up around 5%.
Gold and bonds both up, shares down

PS2: How do the Capital Gains Tax laws compare in the USA?

[MediumTex]

PS2: How do the Capital Gains Tax laws compare in the USA?

"Short term" capital gains (assets held less than one year) are taxed at your regular income tax rate.

"Long term" capital gains (assets held more than one year) are taxed at the 15% capital gains rate.

That is basically how it works.

[AB]

Hal, I assume(d) that capital gains realised on the sale of a bond would be subject to the 50% CGT discount as long as they had been held for more than 12 months?  In that case you'd presumably be better off with a capital gain than actual income which is taxed without the discount?  It starts to get a bit confusing but my normal thinking is that I have a preference for capital gains over income.

For the non-Australian readers, capital gains in Australia are taxed at your marginal rate but you only pay tax on 50% of the gain if you have held the asset for longer than a year.

[Hal]

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

[AB]

It gets confusing pretty quickly when you start thinking of the tax benefits of realising capital gains versus income.  The more I think about it, the more I start to wonder if it's best just to ignore the difference and focus on the strategy (which seems like it should be buying 10yrs out and selling at 9yrs?).

One could (not that I would of course) also include the argument that physical gold can easily be sold for cash without paperwork and hence official capital gains so overall the portfolio might be fairly tax-efficient anyway.