Investment Basics: Duration

Investment Basics: Duration

Learn the basics of bonds, including the concept of duration.

  • Duration, the most commonly used measure of bond risk, quantifies the effect of changes in interest rates on the price of a bond or bond portfolio.
  • The longer the duration, the more sensitive the bond or portfolio is likely to be to changes in interest rates.

What is Duration?

Duration is the most commonly used measure of risk in bond investing. Duration incorporates a bond’s yield, coupon, maturity and call features into one number, expressed in years, that indicates how price-sensitive a bond or portfolio is to changes in interest rates.

There are a number of ways to calculate duration, but the term generally refers to effective duration, defined as the approximate percentage change in price for a 100 basis point change in yield. For example, the price of a bond with an effective duration of two years will rise (fall) 2 per cent for every 1 per cent decrease (increase) in yield, and the price of a five-year duration bond will rise (fall) 5 per cent for a 1 per cent decrease (increase) in rates. The longer the duration, the more sensitive a bond is to changes in interest rates.

 

 

Different Duration Measures

Other methods of calculating duration are applicable in different situations, which we use to enhance our understanding of how bond portfolios will react in different interest-rate scenarios:

  • Curve Duration: this measures a portfolio’s price sensitivity to changes in the shape of the yield curve (that is, a steepening or flattening).

A portfolio’s curve duration is considered positive if it has more exposure to the 2- to 10-year part of the curve.

A portfolio with positive curve duration will perform well as the yield curve steepens, but will perform poorly as the yield curve flattens. A portfolio with negative curve duration has greater exposure to the 10- to 30-year portion of the curve. It will be a poor performer as the yield curve steepens and a strong performer as the yield curve flattens.

  • Spread Duration: this estimates the price sensitivity of a specific sector or asset class to a 100 basis-point movement (either widening or narrowing) in its spread relative to government bonds.
  • Total Curve Duration: this indicates a portfolio’s price sensitivity to changes in the shape of the yield curve relative to its benchmark’s sensitivity to those same changes (see Curve Duration above for characteristics of positive vs. negative portfolios).

The Uses of Duration Tools

Duration can be used in response to expected changes in the economic environment. If the outlook on bonds is bullish (that is, interest rates are expected to fall), duration is then extended. If the outlook on bonds is bearish, interest rates are expected to rise and duration is then reduced.

Fund managers also use duration in an attempt to construct the most appropriate portfolio for a given investor. They may choose to create:

  • Low-duration portfolios, which maintain average portfolio duration of one-to three-years, should be less volatile than longer-duration strategies which are often used as an alternative for traditional cash vehicles such as money market funds. In a low interest-rate environment, a low-duration portfolio can be a higher yielding alternative to money market funds to investors willing to accept additional risk in pursuit of greater return.
  • Moderate-duration portfolios, which maintain average portfolio durations ranging from two-to five-years, could be appropriate for investors seeking higher returns than those offered by money market or short-term investments, but who are averse to a higher level of interest rate risk as measured by duration.
  • Long-duration portfolios, which maintain average portfolio durations ranging from six to 25 years, offer a relatively stable alternative to equities. They may be suitable for an investor looking for a closer match between the duration of their portfolio and their liabilities. Longer- duration strategies tend to benefit from uncertainty in the financial markets that might result in, for example, equity- market volatility or a flight to quality assets such as high quality government bonds.

Equal Duration Does Not Mean Equal Returns

Although duration is an important tool in constructing portfolios, portfolios with the same duration don’t necessarily provide equal returns.

  • For example, a hypothetical portfolio of 10-year government bonds returned 15.4 per cent from October 2000 to October 2001. During the same period, a portfolio of two-year and 30-year government bonds with the same duration as the portfolio of 10-year government bonds produced a return of 11.8 per cent (a difference of 360 basis points).

Why did the two hypothetical portfolios with equal duration have such different returns? Because yields on government bonds of different maturities rarely move in unison. In general, the yield curve tends to steepen when interest rates are declining and flatten as interest rates rise.

  • In the example above, the yield on the 10-year government bonds dropped from 5.80 per cent to 4.59 per cent from October 2000 to October 2001, a 121-basis-point decline. The portfolio consisting of two-year and 30-year government bonds was affected by the significant steepening of the yield curve over the period in question. The 30-year bond went from yielding 14 basis points less than the two-year note in October 2000 to yielding 265 basis points more in October 2001, a 279-basis- point steepening.

Source: PIMCO https://www.pimco.com.au/en-au/resources/education/investment-basics-duration

If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

Investment Basics: Benchmarks

Investment Basics: Benchmarks

Learn the basics of benchmarks, including the crucial role a benchmark serves in investing.

  • There are many different fixed interest indexes that can be used as benchmarks for a fixed- interest portfolio.
  • Choosing the right benchmark for a portfolio is important because the benchmark establishes the risk and return parameters for managing the portfolio.
  • The right benchmark for a given portfolio will depend on the investor’s goals for the portfolio, including the required return, the level of short-term and longer-term risk the investor is willing to assume, and other performance characteristics and requirements, including liquidity.

At a glance

A benchmark serves a crucial role in investing. Often a market index, a benchmark provides a starting point for a portfolio manager to construct a portfolio and directs how that portfolio should be managed on an ongoing basis from the perspectives of both risk and return. It also allows investors to gauge the relative performance of their portfolios; an annual return of 6% on a diversified bond portfolio may seem strong, but if the portfolio’s benchmark returns 7% over the same time period, the bond portfolio has fallen short of its goal.

The number of benchmarks is virtually endless, and selecting the right one is not always easy. To try to simplify the selection process, we examine:

  • What is a benchmark?
  • How is a benchmark calculated? and
  • How and why might a portfolio’s performance differ from its benchmark?

In Benchmarks: Selecting a Benchmark, we also look at the factors to consider when trying to find the best benchmark for an investment portfolio.

What is a Benchmark?

In most cases, investors choose a market index, or combination of indexes, to serve as the portfolio benchmark. An index tracks the performance of a broad asset class, such as all listed stocks, or a narrower slice of the market, such as technology company stocks. Because indexes track returns on a buy-and-hold basis and make no attempt to determine which securities are the most attractive, they represent a “passive” investment approach and can provide a good benchmark against which to compare the performance of a portfolio that is actively managed. Using an index, it is possible to see how much value an active manager adds and where – that is, through which investments – that value is added.

The following are among the most widely followed share indexes, or benchmarks:

 

Numerous other equity indexes have been designed to track the performance of various market sectors and segments. Because shares trade on open exchanges and prices are public, the major indexes are maintained by publishing companies like Dow Jones and the Financial Times, or the stock exchanges.

Fixed income securities do not typically trade on open exchanges, and bond prices are therefore less transparent. As a result, the most commonly used fixed income indexes are those created by large broker-dealers that buy and sell bonds, including Barclays Capital (which now also manages the indexes originally created by Lehman Brothers), Citigroup, J.P. Morgan, and BofA Merrill Lynch. Widely known indexes include the Barclays Global Aggregate Bond Index, tracking the largest global bond issuers. The Bloomberg AusBond Composite 0+ Yr Index, is the most widely used Australian fixed interest benchmark.

Source: PIMCO https://www.pimco.com.au/en-au/resources/education/investment-basics-benchmarks

If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

Moving into aged care

Key takeaways

  • There are three types of aged care which range from the ability to live independently or in supplemented accommodation
  • If your relative wants to apply for Government subsidies to move into an aged care, they must be assessed by a member of the Aged Care Assessment Team (ACAT)
  • You may be required to pay fees in a Government subsidised aged care home, so it’s important to work out the costs.

While there is a strong preference among older Australians to live at home for as long as they can1, there may come a time when they need to move into aged care.

This isn’t an easy decision though— there’s a raft of emotional issues, in addition to financial considerations.

In this article we look at the process to move into aged care and the different types of care available.

Types of aged care

There are three main types of aged care.

Help at home: if your relative prefers to live independently, they can receive care at their home (or a retirement village) when needed. This may include help with personal care needs such as showering and cooking meals, medical care, or other domestic support, such as home maintenance.

Short term care: may be required after a hospital stay or if the regular carer is taking a holiday

Aged care home: supplemented accommodation with 24-hour care available. Can be short term or permanent.

Moving into aged care: the process

If your relative decides moving into aged care is the right move, there are steps required to get the process in motion.

1. Have their needs assessed

To be eligible for Government subsidies, a person must be assessed by a member of the Aged Care Assessment Team (ACAT). This assessment is free and can be done at home, a health centre or hospital.

The ACAT member will ask them a series of questions about their health, mobility and any help that they currently receive at home, to determine whether residential aged care is required based on their needs

2. Find an aged care home

Once ACAT approval is received, you can start looking for relevant accommodation. When evaluating aged care home options, it’s worth contacting a selection of providers to get a better comparison.

If you’re unsure about the facilities and rooms available in a particular area, you can find out more information by visiting myagedcare.gov.au.

It may be beneficial to have a list of questions prepared to ensure you receive the information you need.

These questions may include:

  • What kinds of recreational activities are offered?
  • Are the available rooms shared or single rooms, and is there a private ensuite?
  • What types of other services are regularly provided (such as physio or hairdressing services for example)
  • What food and beverage options are available?
  • Will your relative have access to a phone, internet or mobile phone to contact you?
  • Ask to see a brief report of the Health and Safety report. This is a good indicator with regards to, not only incidents that have taken place, but also incidents against residents and incidents of residents against staff.

Understanding your rights and responsibilities as well as those of the service provider will help you make an informed decision and get the best quality care to suit your relative’s needs.

3. Work out the costs of moving into aged care

There are a number of fees that may be payable in a Government subsidised aged care home. Some of these fees are fixed and others depend on your relative’s financial circumstances. Government subsidies may also be available.

Here’s a general summary of what your relative could be liable for:

Accommodation fees Ongoing care fees
Accommodation payment Basic daily fee Means-tested fee Extra services fee
  • Payable as a refundable lump sum; or equivalent non-refundable daily payment;
    or any combination of
    both
  • The resident chooses how to pay this fee
  • You may be eligible for
    Government assistance in paying this fee
  • Generally payable by all residents for all days in care
  • 85% of full Basic Single
    Age Pension (regardless of your actual Pension entitlement)
  • Payable based on a formula that takes into account your income and assets
  • Subject to change if
    circumstances change
  • Annual and lifetime
    caps apply
  • Payable if you select a position with extra services
  • Additional daily amount, set by facility
4. Apply for an aged home

Generally, multiple applications can be submitted when applying for an aged care home and you may have the ability to be placed on a waiting list.

You will be asked if you want to provide details of your relative’s income and assets but you are not legally required to disclose this.

5. Moving your relative into aged care

Just before they move in, you’ll be provided with an Accommodation Agreement. This is a legal document which sets out the terms of the residency as well as rights and responsibilities for your relative and for the aged care facility. You may want to consider seeking legal advice before signing it.

When your relative does move into an aged care home, don’t forget to notify Services Australia (Centrelink) about their new living situation and any other change in circumstances (e.g. sale of their home, assets used to pay lump sum costs).

Source: MLC https://www.mlc.com.au/personal/blog/2021/06/moving-a-loved-one-into-an-aged-care-home

If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

Superannuation: how does it work in Australia

Superannuation is money that you save during your working life to use as income when you retire.

Like any other investment, the intent is to increase your super account balance, over the long term, while you’re still working. Once you’ve reached retirement, your super savings are generally converted into a pension, providing a regular income for you to live on.

Understanding how superannuation works in Australia, will help you ensure your money’s being managed the way you want it to.

How superannuation works in Australia

If you work in Australia in any capacity, you must be paid super by your employer. This is paid on top of your annual salary known as the Super Guarantee (SG). This includes many people who may consider themselves self-employed but are employed by their own company or trust.

Currently, your employer must contribute 10% of your salary into super. This rate will continue to increase every year until it reaches 12% in 2025.

The intention behind the gradual increase is to see a greater proportion of retirees relying less on the age pension and more on their retirement savings.

Your Future, Your Super

The Federal Government has also introduced a new set of reforms which will see your super follow you from job to job. This means when you start a new job, your employer will be required to pay super into your existing ‘stapled’ fund, if you don’t nominate a new one.

There is also a new YourSuper comparison tool that assists you in choosing a super product to best suits your needs.

How your super is invested

Many of the principles of investing in super are the same as investing outside of super. The main difference is how your investments are taxed: you pay less tax on investment earnings inside super.

If you are a member of an industry, retail, corporate or public sector fund, your money is combined with other peoples’ super to buy investments. This enables your super to grow in two ways:

  • growth in resale value called capital growth
  • reinvested income such as rent or dividends.

If you don’t actively choose how you want your money invested when you join a fund, you will be placed in a default investment option. These are designed to cater for a large group of people, based on specific investment criteria that the fund must deliver to. Normally, these options have around 60-80% of their funds invested in growth assets such as shares and property.

It’s important to regularly assess how your super’s invested and make changes if necessary. For example, taking a more conservative approach, means you’ll have higher exposure to cash and fixed-income assets as they offer less risk than shares and property.

What are the main types of super funds?

Superannuation funds can be broken down into five different types:

Corporate/employer-sponsored super funds

Some medium to large businesses have their own super fund which is only available to their employees. They can offer tailored fee and insurance arrangements, and a wide range of investment options.

Industry funds

Industry funds were originally established to support employees within a particular sector but most are now open to everyone. They stand by a non-profit, member-first ownership model and re-distribute profits from investments directly to members.

Retail funds

These funds are run by banks, financial institutions or investment companies, designed to give members a vast array of investment options. The company that owns the fund generally aims to keep some profit which is paid to shareholders.

Public sector

Designed for people working in the public sector, these funds have limited investment options but low fees. Profits remain within the fund for the benefit of members.

Self-Managed Super Funds (SMSFs)

SMSFs enable you to have complete control over how your retirement savings are invested—a private super fund that you manage yourself.

Personal super contributions

The 10% of your salary that your employer contributes into super may not be enough to sustain the lifestyle you currently have, or the one you wish to have, during your retirement.

There are a range of strategies you can implement to improve your retirement savings, like putting a little extra money into your super while you’re still working.

Personal super contributions—those made from money you’ve already paid tax on such as savings or your take-home pay—are tax deductible. These contributions can be claimed against your assessable income when you lodge your tax return.

The rules on personal tax-deductible super contributions

There are rules surrounding tax in super that you should be aware of.

  • Personal contributions are concessional contributions so, they’re capped at $27,500 per financial year1. If you choose to contribute over this amount, you may be required to pay more tax.
  • Your personal super contributions are taxed at 15%2 which is significantly lower than what most people pay on their taxable income (the highest marginal tax rate is 47% if you include the Medicare Levy).
  • Higher income earners (on more than $250,000) are taxed at 30%3 on contributions. That’s a decent extra tax hit—but still a lot less than the top marginal tax rate.
  • If you’re a lower income earner on a marginal tax rate of 15% or close to it, there may be little advantage in making a tax-deductible super contribution. Speaking to a financial adviser can help you decide the best approach.
  • If you’re 67 or over you need to meet a work test before you can make a personal super contribution. This means you must have been employed during the financial year for at least 40 hours over a period of no more than 30 consecutive days.

Tax on super investment earnings

Your super fund pays tax on your behalf for any income or profits your make from your investments. The tax is reflected in the daily unit price for each investment option.

  • Super account investment earnings are taxed at a rate of up to 15%
  • Retirement pension account investment earnings are not taxed.

Bottom line: Super is harder than it probably should be—but better than you think. The mix of a whole range of tax savings, structured long-term investing and regular contributions make it a powerful engine for delivering an anxiety-free retirement.

Source: If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

Why understanding your risk tolerance can help build greater confidence for retirement

By Ninda Hendy

The content is produced by the Good Weekend in commercial partnership with MLC.
When it comes to our nest egg, some of us are happy to simply rely on the wonders of compound interest to grow the balance. Others, meanwhile, leave it up to their super fund to take a few calculated investment risks on their behalf, confident it will pay off later.

How we feel about the financial risks that we take to grow our superannuation is known as risk tolerance.

In simple terms, an investor with a high-risk tolerance is more likely to risk losing some money occasionally in order to get better long-term results.

An investor with a low-risk tolerance, however, tends to favour investments that are more likely to preserve their original investment.

Risk tolerance is determined by a combination of factors, including your financial experiences, investment goals, what sort of retirement you would like to enjoy and how much time you have to invest.

Understanding your individual risk tolerance is an important step in understanding how super works. Investing based on your tolerance can have a big impact on the money available to you later in life, so it’s well worth taking the time to understand it now.

Growing an appetite for risk

Sydney couple Kiri Yanchenko and Wesley Taylor, founders of Australian skincare brand Amperna, have poured everything they have into their business, both personally and financially. And they are serious about growing their super.

The small business owners contribute 10 per cent of earnings each month to their super to mirror what they would be receiving if they were employed, based on the current national super guarantee.

Yanchenko says her appetite for risk has improved over the years, after watching her parents fight to keep the family home back in the 1980s. At the time, interest rates were hovering at an eye-watering 17 per cent, so making mortgage repayments was tough. Conversations about money were rarely positive, she says.

“That experience definitely determined my appetite for risk. I grew up erring on the side of caution when it came to money,” Yanchenko says.

But her husband, Wes, had a different experience growing up, and together, they decided it was worth taking a few calculated risks with some help from a financial planner.

Their super is diversified into both international and Australian shares, property and cash investments – and it has paid off already, with the couple well on track to retire comfortably.

“At the moment, given our age and where we are in life, we have a higher risk tolerance. So, we’re investing in high risk options,” Yanchenko says, adding that
they have organised quarterly reporting from a financial adviser to keep a close eye on progress.

“There’s some movement in our super balance each quarter, but in our view the longer term financial rewards far outweigh the risks.”

Calculating risk

Determining someone’s risk appetite is an important part of the job for MLC principal financial adviser Pete Brewster. He does this by asking customers a series of questions, before recommending tailored investment solutions.

“With the right context we can understand what you want to achieve and how this fits with your risk tolerance,” he explains.

“It doesn’t make any difference whether you’ve got a lot or a little in superannuation. Either way, you need to understand how your approach to risk will impact your superannuation and investment balances.

“It’s about knowing yourself well enough financially to understand what you’re comfortable with and making sure the investments made on your behalf reflect your risk appetite,” says Brewster.

For example, asset types that investors with a high-risk tolerance might consider are Australian and international shares, residential and commercial property.

“It might even be appropriate for some who are still accumulating assets and have a long-term approach to borrow to invest or ‘gear’. These types of investments may come with a lot of uncertainty day to day, and some risks of short-term losses, with an aim to gain for profit in the medium to long term,” Brewster explains.

In contrast, investors with a lower risk tolerance typically seek more certainty and security, with the knowledge they can withdraw exactly what was invested at any time.

“Alternatively, assets like term deposits or fixed interest investments might be more suitable for people with a low-risk tolerance who are happier to receive a much lower return for their peace of mind, more certainty and less ‘ups and downs’ in the short term.”

It’s a valuable conversation for anyone to have. “Once your appetite for risk is understood, you can have more confidence around your financial future and make better decisions to build your nest egg,” Brewster adds.

Eric Blewitt, CEO of stockbroker AUSIEX agrees. Super is a long-term investment, so you should consider its performance over the longer term. It’s not conducive to apply short-term thinking by tracking the daily fluctuations of the market, he says.

As you get closer to retirement, your financial adviser can help you assess the risk profile of your investments. They can discuss how to best structure your portfolio, which may involve transitioning into assets that are more stable, but still produce good growth and income.

“After all, retirement for many is a 20-plus year outlook. You want your money to continue to grow in a stable manner, as well as being able to withdraw funds to enjoy your retirement,” says Blewitt.

“Planning for retirement is an important exercise that involves investment and tax considerations. It’s advisable to seek advice in both areas to set yourself up confidently for retirement.”

Source: MLC https://www.mlc.com.au/personal/blog/2021/10/understanding-your-risk-tolerance

If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.

Video – 2022 Focus: Expanding the Opportunity Set

2022 Focus: Expanding the Opportunity Set

With inflationary risks and less accommodative policies likely to increase volatility, PIMCO Group CIO Dan Ivascyn offers strategies that may hedge inflation, broaden the opportunity set and potentially earn stronger returns from more complex areas of the market.

Watch the 8 minute video here.
Source: PIMCO https://www.pimco.com.au/en-au/resources/video-library/media/2022-focus-expanding-the-opportunity-set
If you have questions and would like your financial situation to be evaluated, please email us on ds@bluerocke.com with your contacts, for an exploratory meeting, at our cost, not yours.