Investing in government bonds – when to bother

Co-founder of the Switzer Report
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My first job in financial markets was as a government bond trader for an investment bank – in fact, I spent almost a decade and lost quite a bit of hair doing this – so you may be a little surprised to hear that I am not getting too excited about the launch of government bond trading on the ASX.

While it will make it easier for SMSFs and others to invest in government bonds, it is not new. Contrary to the many misinformed commentators, small investors have always been able to invest in government treasury bonds – the Reserve Bank has offered a small bond facility for more than 25 years! This old service will now be closed to new purchases.

ASX trading

Let’s start with the new service. From Tuesday 21 May, investors will be able to buy or sell on the ASX, Australian Government Exchange-Traded Treasury Bonds (or eTBs) and Exchange-Traded Treasury Indexed Bonds (or eTIBs). These bonds will trade on the ASX like other hybrid or income securities and have a face value of $100.

Technically, eTB and eTIB holders will hold a CHESS Depositary Interest (CDI), which represents an underlying Australian Government treasury bond. These CDIs enjoy all the benefits of owning a government treasury bond (payment of interest, repayment of principal on maturity), and can be converted into the underlying bond. Market makers, institutions and stockbrokers will be able to make the conversion, which should mean that the eTBs trade at roughly the same price as the institutional/wholesale bond price.

Initially, the ASX will be listing 16 different eTBs, with maturity dates from one year out to 16 years. The longest bond matures on 21 April 2029 and will trade under the ASX stock code GSBG29. It pays a semi-annual coupon (or interest) of 3.25% per annum (on 21 April and 21 October each year), and has a face value of $100.

Taking an example – an SMSF may wish to purchase 200, 3.25%, 21 April 2029 ETBs. On 21 May, the eTB may cost $105.00, so the fund would pay $21,000 (plus brokerage) for $20,000 face value of eTBs. If the fund holds the eTBs until maturity, it will receive $325 of interest every six months ($3.25 / 2 x 200), and on the maturity date in 2029, the principal (face value) of $20,000.

Five Exchange-Traded Indexed Bonds are also being listed. eTIBs can provide protection against inflation, with the coupon (or regular interest payment) and the face value increasing each quarter, with changes in the Consumer Price Index. The longest eTIB is the 2.5% 20 September 2030 bond, which will trade on the ASX under the code GSIQ30. This treasury indexed bond was first issued in September 2010, and through indexation, the adjusted face value has grown to $107.59.

How to trade

Like any share or income security – access your broker online (or via the phone), key in the ASX code, the number of units (face value of $100 per unit), your bid price – click the mouse, and you are now the owner of treasury bonds. Settlement will occur in three business days, and you will receive a CHESS holding statement in the mail. Coupons (interest) will be paid to the bank account you nominate.

The Government has developed a reasonably smart website that contains the terms of each bond and other information – go to www.australiangovernmentbonds.gov.au.

Why bother?

SMSFs and private investors aren’t faced with the size constraints that institutional investors sometimes face – they are small enough to invest in most things. Rightly or wrongly, a perverse outcome of the GFC is that “retail” interest rates are now considerably higher than “wholesale” or “institutional” rates. Why should an SMSF invest in a five-year treasury bond when it can increase its return, over and above the government bond, by around 1.5% to 2.0% per annum by investing in a “government guaranteed” term deposit?

While there are limitations with the guarantee (it only applies on deposits of $250,000 on a per name per institution basis), there is enough choice out there with so many “government guaranteed” Authorised Deposit Taking Institutions and other low-risk fixed-income securities, such as Waratah bonds from the NSW state government.

When to bother

There will be times when it makes sense to look at the eTB or eTIB markets. Firstly, most banks won’t issue term deposits beyond five years – so if you want a fixed-income portfolio with a long duration, or think interest rates are going to fall, then an ETB is the way to go. Secondly, if the market develops some real liquidity and you have an informed view on interest rates, you can potentially trade bonds like shares. Brokerage and transaction costs through the bid/offer spread become really critical here, so it is much harder to cover your transaction costs with bonds than it is with shares. Finally, eTIBs may suit investors concerned about the real value of their retirement assets and incomes, although in an era of low inflation, the attraction of an eTIB is less strong.

And if I haven’t diminished your enthusiasm by now, have a look at the closing government bond yields on Friday. I am the first to admit I have been wrong about the bond market this year. That said, I can see no real downside risk in not holding bonds at these levels – a yield to maturity of 3.47% for 15 years does nothing for me.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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