In recent weeks the interest rate on 10 Year Australian Government bonds hit their highest points in more than 15 years. It was back in May/June 2011 when the bonds issued by the Commonwealth were above 5.30%. During September and October (month to date) the Australian 10 year yield has fluctuated between 5.20% and 5.40%.
Why do we care?
The fact is that the ‘risk-free’ rate of return for investing long term sets the ‘hurdle’ for any other type of investment.
It is also relevant that 6 years ago was probably the worst time ever to be investing in Government Bonds. Then, buying a 10 year Government bond in October 2020 guaranteed you a measly 0.77% return per annum over the following ten years.
We think the nominal levels of longer term bonds have now reached a point where they finally have a role in adding diversification and protection to portfolios. That is something new. We have seen very little value in long term bonds for many years and tended to keep durations short (1 to 3 years) as a protection against capital losses when interest rates rise. That is now changing.
Educating our clients
It is quite probable that as we complete portfolio reviews over the coming months we will be talking more and more about fixed interest and adding various investments in that segment to your portfolios. Some of the Managed Accounts that we use for clients are already moving in that direction.
As a primer to that we have completed some research into some of the well known Exchange Traded Funds that invest in that segment of the market.
Exchange Traded Funds that invest in Bonds
While there are many ETF’s that in one way or another may be described as Bond ETF’s or Fixed Income ETF’s we want to focus here on the core ETF’s that invest in traditional type bonds as well as two that focus on short term floating rate bonds issued by banks. The codes we will focus on are: BSUB, QPON, CRED, VACF, VAF, VGB, RSM.
Below are the most recent portfolio-level yield to maturity (YTM) and maturity/duration figures from the ETF managers. Note the duration measurement differs by manager: Betashares and Russell publishes modified duration, Vanguard publishes effective duration.
Meaning of YTM and Maturity/Duration
Yield to Maturity (YTM) is a reference to the annualised rate of return that is expected on the current portfolio of bonds. If you held all the bonds in the CRED ETF below until each matured, your annualised return would be 6.67% per annum.
Maturity/Duration is a reference to how long the average maturity is. Again, looking at CRED, the average maturity of all the bonds in the portfolio as at today is 8.2 years. That is a fairly long duration. Importantly, the longer the duration, the more sensitive they are to changes in market interest rates. There is a complex formula to calculate sensitivity, but for the purpose of this discussion we will keep it simple. Using CRED as the example again, the current YTM is 6.67%. If the market interest rate on that portfolio fell to 5.67% (down 1%) then all other things being equal we would expect the capital value to have increased by 8%. One percent for each year of Maturity/Duration.
| ASX code | ETF | Latest YTM | Avg Maturity | Data date |
| CRED | Betashares Australian Investment Grade Corporate Bond ETF | 6.67% p.a. | 8.2 years | 30/09/2026 |
| VACF | Vanguard Australian Corporate Fixed Interest Index ETF | 5.54% p.a. | 4.2 years | 31/08/2026 |
| VAF | Vanguard Australian Fixed Interest Index ETF | 5.10% p.a. | 5.9 years | 31/08/2026 |
| VGB | Vanguard Australian Government Bond Index ETF | 5.03% p.a. | 5.3 years | 31/08/2026 |
| RSM | Russell Investments Australian Semi-Government Bond ETF | 4.95% p.a. | 3.42 years modified duration | 31/08/2026 |
| BSUB | Betashares Australian Major Bank Subordinated Debt ETF | 6.05% p.a. estimated yield to worst | 0.13 years modified duration | 30/09/2026 |
| QPON | Betashares Aust Senior Bank Floating Rate Bond ETF | 5.63% p.a. | 0.13 years modified duration | 30/09/2026 |
What is the difference?
- CRED holds long term bonds issued by Australian corporations. It has the highest stated YTM among the confirmed figures, but also the longest duration, so it has materially greater sensitivity to Australian interest-rate moves than VACF or RSM. Also, in a recessionary environment, although yields may fall, (increasing the value of the bonds) credit spreads can widen, which could offset some of the benefits of falling rates. Average credit rating is BBB+
- VACF is similar to CRED but with a shorter duration. As a result, the current yield to maturity is also a bit lower and would always be so. Average credit rating is A+
- VAF is a broad Australian composite fixed-interest exposure, made up mostly of government bonds with some corporates. VAF holds the broadest range of bonds with over 900 bonds in the portfolio. Average credit rating is AA+
- VGB consists solely of Commonwealth and State government issued bonds, making it the most secure from a default perspective. It holds over 164 bonds with an average credit rating of AAA.
- RSM is invested into Semi-Government bonds with a maximum maturity of 5 years. Current duration is 3.42 years making it somewhat less sensitive to interest rate movements.
- BSUB holds Teir 2 floating rate subordinated bonds issued by the four major banks. While not as secure as Senior Bank Bonds, the market for Teir 2 bonds is strong. In a bank stress scenario spreads could widen, reducing the value of these bonds. Because duration is very short investors would not be hurt by rising rates, but would likewise not benefit much if rates were to fall.
- QPON holds senior floating rate bonds issued by the major Australian Banks. 80% of the holdings are issued by ANZ, CBA, NAB or Westpac. The remainder are from other Australian Banks. Average credit rating is AA-. Because the duration is short, we don’t expect a large change in value with any rise or fall in interest rates.
Defensive Characteristics
What many people fail to understand about Bonds is the ‘defensive characteristic’. As mentioned earlier, when interest rates fall, the value of a secure bond can rise and produce a capital gain in addition to the income you get from the coupon payments. In the table above we mentioned the Vanguard Government Bond VGB with a duration of 5 years. If rates fell from 5% currently back to 4% in the near future, your return might be 5% income plus a 5% capital gain for a total gain of around 10%.
Yield to Maturity may not represent annual distributions
A word of warning. While a bond is generally quoted with a ‘Yield to Maturity’ that does not mean you will see that appear as a regular income payment. As our earlier article discussed, the coupon interest rate on a bond is fixed at issue date. A bond issued back when interest rates were low might have had a six monthly payment of $1.50 per $100 of face value. So it has a 3% annual ‘coupon’. But if that bond has only one year to maturity, and the current ‘yield to maturity’ on that one year bond is 5%, then the bond is likely trading at $98.00. It will mature in 12 months at $100 but your income payments are made up of 2 payments of $1.50 each and a gain of $2.00. By the way gains on holding a bond directly are classified in tax law as income.
The message here is that we don’t expect a straight line of income from a bond or a bond ETF. The returns are not known exactly in advance. If interest rates go up, the current market value of your bond or ETF could go down.
Which one is right for you?
Since this advice is not tailored to your specific situation there is no right answer. What is important is understanding the different characteristics of each. If you are convinced we are headed for a deflationary recession with much lower interest rates, then the VGB might be your preference. If you see interest rates moderating somewhat but without a recession and you want a higher yield, then the CRED might be your preference. If you want big four bank level security but think rates will go quite a bit higher yet, then QPON might be your choice. Or maybe a well considered blend.
All information in this report is General Advice only. It does not take into account your objectives, personal situation or needs. You should consider whether this advice is suitable for you and your personal circumstances. If a financial product is mentioned, you should obtain and read the relevant product disclosure statement before making any decision to invest or dispose of the product. Our advice is that you should always ask for personal advice before acting unless you are a subject matter expert.
