au en false false
 

Bond yields and inflation have been in the news. The inverse relationship between yields and bond prices means that rising yields is putting pressure on the returns of bonds. This is a problem for investors who rely on bonds as the defensive allocation of their portfolios. There are ETFs that can help investors manage these risks.

Bond yields and inflation have been in the news. The inverse relationship between yields and bond prices means that rising yields is putting pressure on the returns of bonds. This is a problem for investors who rely on bonds as the defensive allocation of their portfolios. There are ETFs that can help investors manage these risks.

Inflation concerns
Government bond yields jumped in September and October over renewed inflation concerns particularly in Europe. 10Yr UK Gilts government bond yields have doubled over two months with markets expecting Bank of England rate rise shifting to early 2022. Challenges combating COVID-19 have disrupted supply chains. Companies are reporting significant input price pressures notably higher wages, raw material prices and transportation costs. World shipping container costs have jumped 90% year to date. 

Chart 1 – 10 year government bond yields                     Chart 2 – WCI World shipping costs
imageitz3nq.png
Source: Bloomberg                                                                       Source: Bloomberg, WCI Composite Container Freight Benchmark                                                                                                        Rate per 40 Foot Box.

Impact on fixed income investments
Rising bond yields have adversely impacted fixed income investments due to the negative relationship between changing yields and bond prices. The impact of changing yields on bond prices increases as time to maturity increases. Bloomberg Ausbond Government 0-5Yr and 10+Yr index returned -0.39% and -11.99% respectively between November 2020 and February 2021 when Australian government bond 10yr yield increased by 1.17%.

Chart 3 - Australia Government Bond Indices at different maturity terms drawdown versus 10 year bond yield
image47h6.png
Source: Bloomberg, Bloomberg Ausbond Government 0-5Yr, 5-10Yr and 10+Yr indices.
  
Alternative to mitigate duration
Modified duration quantifies the impact of a change in yield on bond prices. Floating rate debt instruments mitigate duration risk as coupon payments are variable as opposed to fixed which offsets the effect of changing interest rates on valuations.

Table 1 - Modified duration comparison

Instrument

Average time to maturity (yrs)

Modified Duration (yrs)

1% govt bond yield increase bond price impact (%)

Australian government bonds 10+ yr

14.69

11.90

11.90%

Australian government bonds 5-10 yr

7.49

6.78

6.78%

Australian government bonds 0-5 yr

2.74

2.62

2.62%

Australian corporate floating rate notes

1.92

0.13

0.13%

Australian subordinated debt

3.58~

0.08

0.08%

Source: As at 30 October 2021. Australian government bonds as Bloomberg Ausbond Government indices at different maturity terms. Australian corporate floating rate notes as Bloomberg Ausbond Credit FRN 0+ Yr Index, Australian subordinated debt as iBoxx AUD Investment Grade Subordinated Debt index.
  
Chart 4 – Drawdown comparison versus 10 year bond yield


Source: Bloomberg, Bloomberg Ausbond Government 0-5Yr index. Australian corporate FRN as Bloomberg Ausbond Credit FRN 0+ Yr Index, Australian subordinated debt as iBoxx AUD Investment Grade Subordinated Debt index.
  
Access
VanEck offers two floating rate income ETFs listed on the ASX across different investment risk/return profiles;

We always recommend speaking with your financial advisor or broker to determine which investment risk/return profile is appropriate for your circumstances.

Published: 15 November 2021

VanEck Investments Limited ACN 146 596 116 AFSL 416755 (‘VanEck’) is the responsible entity and issuer of units in the VanEck Australian Floating Rate ETF (FLOT) and VanEck Australian Subordinated Debt ETF (SUBD). This is general advice only, not personal financial advice. It is intended for use by financial services professionals only. The PDS is available here. The Target Market Determination is available here.

An investment in FLOT and SUBD carries risks associated with bond markets generally, interest rate movements, issuer default, credit ratings, fund operations, liquidity and tracking an index. See the PDS for details. No member of the VanEck group of companies guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from any fund.