Fixed Interest Asset Allocation versus Fixed Interest Securities

It is BR Securities view that any fixed interest security can be purchased if the reward for the risk is there. However, not all fixed interest securities belong in your fixed interest, low risk portfolio allocation.
By · 18 Jan 2015
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18 Jan 2015
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The fixed interest (or fixed income) asset allocation is the low risk, stable one there to earn low risk income and limit capital losses in a crisis.  The size of the allocation will vary depending on an investors own circumstances.  30% is a starting point, but for older people maybe 50 to 100% and for younger maybe 0%.  

Such a portfolio should only contain such things as term deposits, government bonds, and low risk corporate bonds with average maturities of less than 2 years.  Limiting the maturity date limits the negative capital impacts from widening credit spreads and rising interest rates and limiting the risk makes the income predictable. 

The ASX contains a few securities that fit this low risk category being the CBA bond, the Aust Unity bond, the Tatts bond, the Primary Health Care bond as well as, just, the Tier 2 bonds issued by WBC, NAB and ANZ which are not Basel 3 compliant (because they don't have the nasty options that APRA can use).  You can also add in some shorter term Australian Government bonds now also traded on the ASX along with unlisted term deposits to build a suitable portfolio.  An Exchange Traded Fund whose assets are also low risk would suit, and we'll get back to you on the best ones.

The return from your low risk portfolio is what it is.  You can't do too much about it.  If you want to increase return you need to take more risk, something that is illogical to consider when targeting a low risk portfolio.  If you want to take more risk you need to take a step back and look at your asset allocations.  You might want to reduce your fixed interest portfolio from 30% to 20% to chase more return.  Do it that way rather than changing the mix of your fixed interest portfolio.  

Your return seeking portfolio which can include shares, property, hedge funds, and other speculative activities can also contain fixed interest securities.  Not all fixed interest securities belong to the fixed interest asset allocation.  Most on the ASX don't but you can still buy them.  

You can segment your return seeking portfolio into risk levels.  Some hybrids, such as the NABHA, MBLHB and MXUPA, we (BR Securities) regard as less risky than other hybrids on the ASX.  These can sit in a low risk, return seeking bucket.  We've (BR Securities) calculated the odds on each of these defaulting, as well as the odds on any embedded options being exercised, and the returns are excessive.  More risky corporate bonds such as the Peet Group or MYOB notes can also sit in this lower risk return seeking allocation.  They are too risky for the fixed interest allocation but not as risky as shares.

In the high risk return seeking bucket sit your shares, property and any speculative strategies. eg margin loan strategies, trading FX etc.  The Alt Tier 1 Basel 3 compliant bank hybrids fit here.  The margin on such hybrids isn't high enough yet for the odds of loss, in our (BR Securities) opinion, but if you did buy them this is where they would sit, alongside shares and property.  

It is our (BR Securities) view that any fixed interest security can be purchased as it is all about the reward / risk aspects.  You have to assess the odds of loss and make sure you are getting a good reward.  More important, however, is allocating the investment to the correct portfolio.
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David Bickford
David Bickford
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