Future Funds Blog

Monthly Report – June 2017

Grant Simpson - Thursday, June 01, 2017

Monthly Report – June 2017

Although sharemarkets were generally flat between the start and finish of the month, it was Bond markets that saw the most turbulence over the last month with a realisation Global rates are indeed going up. Seemingly unified announcements from multiple Central Bank Governors from around the world shook fixed interest markets quite significantly. Even though our own new Reserve Bank boss Phillip Lowe remained on the sidelines and kept Mum, the Australian fixed interest market showed some of the biggest changes we've seen in a long time.

Australian 3-year Government Bond yields leapt from 1.65% to 1.94%, and 10 year yields went from 2.39% to 2.60%. Although yields going up sounds like a good thing, remember that in the Bond world, Bond trading values (i.e. prices) move in the opposite direction to yields. So, that 3yr Bond yield increase of 0.29% translates to around a 0.8% decrease in Bond Prices. Given that these Bonds and Bond funds are supposed to be the stable assets in our portfolios, that is a reasonably large move. The 10 year Australian Government Bond yield increase of 0.21% translates to a 2% decrease in those longer term Bond prices - an even bigger change.

Usually, investing in a longer term bond provides returns because you are giving up access to your money for longer, however, those two results above demonstrate one other important factor - when interest rates are going up, you don't want to hold very long term Bonds because they are more heavily impacted by yield changes than short term bonds. The managers of the funds we use in our portfolios report that their average maturities across their portfolios now is around 6 months, so theoretically they shouldn't be too impacted, but if you want to understand the dip you might see in your funds this month, that's where it is coming from. One thing to be comforted by though is that the impact of these Bond Yield changes is short term. If you hold (say) a 3% p.a., 3-year Government Bond through to maturity, it will pay you, the holder, 3% p.a., even though its market value will fluctuate with yield changes, up until the day it matures. Through that process, the market value gets closer and closer to equalling a 3% p.a. return as it gets closer to its maturity date. So, it's reported daily value (i.e. market value) may fluctuate, but if the Bond isn't sold on the market before its maturity, then the reported value on a particular day doesn't actually mean much, other than for monthly reports like ours. Straight forward right?!!

One good thing about lifting yields though is that they usually indicate the likely next shift in rates in the future is up. In Australia's case though, the timing of that increase seems to be drifting even further out. Remember that graph I showed a couple of months ago? Here's the updated version;

http://www.asx.com.au/data/trt/ib_expectation_curve_graph.pdf

It's now showing the market isn't expecting a lift in official interest rates until November 2018. So, the yield lift we are seeing in Australian Bonds is actually about us keeping up with the rest of the world, even though our own economy can't really support higher interest rates. I know that this talk about Bond Prices and Bond yields can be tough to follow, but I suspect it's going to be the thing that drives markets the most over the next few months, so I'll endeavour to keep it as uncomplicated as possible as we go forward.

On a slightly brighter note, we had an interesting outcome in the last few days. We have some recently retired clients who have been struggling to get Centrelink to finalise their January applications for the Aged Pension and the Pension Bonus Scheme. They were really being disadvantaged by the fact that their file appeared to be moving from one "Too Hard" basket to the next. We got in touch with our local Member's office (Jason Fallinski), and they were equally appalled by the length of time this had taken to be addressed. They brought it to the attention of the Minister of Social Security, and, low and behold, the issue was completely solved within 4 days. Jason's staff were excellent and our clients were very relieved and happy. It's a great reminder that your local Member wants to be aware of these issues and can make a big difference.

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