CRED/QPON – a fixed income blend with the potential for higher returns and improved portfolio diversification
Key Takeouts
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Weighted based on expected returns |
Historical outperformance |
Low cost |
CRED selects bonds based on expected returns, seeking to avoid drawbacks of traditional liability-weighted indices |
A 91% /9% blend of the indices which CRED/QPON aim to track outperformed the AusBond Composite index by 2.1% p.a. over the last 11 years* |
Management fees of 0.25% p.a. (CRED) and 0.22% p.a. (QPON) |
*Illustration only. Not a recommendation to adopt any particular investment strategy. Past performance is not indicative of future performance.
Investment grade, fixed rate bonds are generally acknowledged as a core element of a diversified portfolio. As well as the potential returns they provide, a fixed income allocation offers portfolio diversification benefits, given that such bonds historically have had a low correlation with equities.
The traditional liability-weighted approach
The Bloomberg AusBond indices are the established benchmarks for the performance of the Australian fixed income market.
As such, many fixed income funds and ETFs aim to track the Bloomberg AusBond Composite 0+ Yr Index. This index includes investment grade fixed income securities issued by government and semi-government entities, supranational and sovereign entities, and corporations.
A typical portfolio approach is to allocate a percentage of funds to equities, and a percentage to a fund that tracks the AusBond Composite index.
The AusBond indices are liability-weighted. Among issues that are eligible for inclusion in the index, the larger the amount of bonds outstanding in that market, the higher the issue’s weighting in the index.
We believe there is a better approach.
Ranking by expected returns
Our Australian Investment Grade Corporate Bond ETF (ASX: CRED), instead of taking a liability-weighted approach, aims to track an index that ranks eligible corporate bonds by their expected returns relative to government bonds of a similar maturity.
In the 12 months following inception on 31 May 2018, CRED was the best-performing fixed income fund, exchange-traded or unlisted, in Australia among the 218 funds in Morningstar’s database, returning 11.36%, against the median fund return of 5.94%.
We believe that a holding of CRED, in combination with a holding of our Australian Bank Senior Floating Rate Bond ETF (ASX: QPON), has the potential to offer both superior returns and better diversification benefits than a fund that tracks the AusBond Composite Index.
How has the CRED/QPON combination performed?
As the table below shows, a holding of 91% CRED’s Index and 9% QPON’s Index produced higher returns than a 100% allocation to the AusBond Composite index for a range of periods over the last 11 years. The annualised return from 1 April 2008 to 31 July 2019 for the blend was 8.5% compared to a return of 6.3% for the AusBond Composite.
Source: Morningstar Direct. Illustration only. Not a recommendation to adopt any particular investment strategy. Shows performance of indices in combination, not ETFs, and does not take into account ETFs’ fees and costs. Past performance is not indicative of future performance. You cannot invest directly in an index.
Because CRED and QPON entail exposure only to corporate bonds, compared to the AusBond Composite’s government bond component, volatility is slightly higher at 3.74% p.a. for the CRED/QPON index combination over the 11 years vs. 2.88% p.a. for the AusBond Composite. However, the additional return more than compensated for the higher volatility, with the CRED/QPON index combination showing superior risk-adjusted returns (Sharpe ratio of 1.38 vs. 1.09 for the AusBond Composite)1.
Performance in combination with equities allocation
We compared the returns from two portfolios:
- 50% Australian equities/45% CRED/5% QPON Index allocation, and
- 50% Australian equities/50% AusBond Composite Index allocation.
As shown in the table below, the CRED/QPON Index blend, when paired with equities, produced superior returns over every time period shown.
Source: Morningstar Direct. Illustration only. Not a recommendation to adopt any particular investment strategy. Shows performance of indices in combination, not ETFs, and does not take into account ETFs’ fees and costs. Past performance is not indicative of future performance. You cannot invest directly in an index.
The blend of CRED/QPON/Australian equities indices also offered defensive benefits, with a maximum drawdown of 16.0% over the period, compared to the maximum drawdown of 38.5% for Australian equities alone (as measured by the S&P/ASX 200 Index), and 16.2% for the AusBond Composite/Australian equities indices blend.
Current yield to maturity
As at 31 July 2019, the CRED/QPON Index combination provided a yield to maturity of 2.39% p.a. compared to the AusBond Composite’s 1.10% p.a., with an almost identical modified duration.
Modified duration (years) | Yield to maturity (% p.a.) |
Weight | |
CRED’s Index | 6.10 | 2.46% | 91% |
QPON’s Index | 0.11 | 1.65% | 9% |
91:9 Portfolio | 5.56 | 2.39% | |
AusBond Composite | 5.57 | 1.10% | |
Difference | 0.01 | 1.29% |
Source: BetaShares, Bloomberg. As at 31 July 2019. Shows performance of indices in combination, not ETFs, and does not take into account ETFs’ fees and costs. Past performance is not indicative of future performance. Yields will vary and may be lower at the time of investment. You cannot invest directly in an index.
For more information on the two funds, go to CRED and QPON.
There are risks associated with investing in the Funds, including interest rate risk, credit risk and index tracking risk. The value of an investment and income distributions can go down as well as up. Before making an investment decision investors should consider the relevant PDS and their particular circumstances, including their tolerance for risk, and obtain financial advice.
1. Source: Morningstar Direct