Guide to superannuation threshold changes

Guide to superannuation threshold changes

Changes to superannuation thresholds from 1 July 2021 to 30 June 2022

Transfer Balance Cap

The transfer balance cap rules commenced on 1 July 2017. It is a limit on the amount of superannuation a member may use to commence a tax free pension in retirement phase. It is also the level at which you may not make any further non-concessional superannuation contributions. From 1 July 2021, this transfer balance cap will increase from $1.6 million to $1.7 million.

Non-Concessional Contribution Cap

The non-concessional superannuation contribution cap will also be indexed up from $100,000pa to $110,000pa and so the 3 year bring forward rules will enable you to make a $330,000 non-concessional contribution.

Concessional Contribution Cap

The concessional superannuation contribution cap will also be index up from $25,000pa to $27,500pa. Concessional contributions include employer SG (super guarantee), salary sacrifice or deductible super contributions.

Superannuation Guarantee (SG)

The contributions you will receive from your employer will rise to 10%pa from 1 July 2021. Employers will need to pay this on salaries of up to $58,920 per quarter.

The increase in contribution limits is always a noteworthy event, given it tends to only occur every 4-5 years. For those considering utilising the 3 year bring forward provisions, it may be worth considering deferring these payments for 6 weeks. This also applies to those who were considering using their superannuation to purchase a retirement income stream prior to 1 July 2021. If you would like to discuss these changes and how to best take advantage of them, please feel free to contact us. We will be more than happy to assist.

Why hybrids offer defensive potential but have strings attached

Why hybrids offer defensive potential but have strings attached

This article appeared in the Australian Financial Review.

When the best term deposit rate you can get is below 1% from a bank you may never have heard of, the chance to get 4% or better on a hybrid security from one of the big four tends to grab your attention. The problem is, of course, those attractive rates come with all kinds of strings attached.

After emerging 25 years ago as a handy solution for companies to raise money and for share market investors to be able to access higher yielding securities, hybrids have become an entrenched part of the Australian market. However, while they can readily play a role in a smart investor’s well-structured portfolio, they are devilishly complex. There is a variety of structures and features requiring issuing documents that can run into the hundreds of pages, enough to prompt government websites like Moneysmart to describe them as ‘very risky’.

The ‘hybrid’ label is because they blend elements of debt securities and equities, that is, they are part bonds and part shares. Typically they promise to pay a rate of return, which you can think of as an interest rate, for a certain period of time, and at the end of that period, the investor gets the original face value of the security, which is normally $100, in shares.

The interest rate is usually quoted as a margin above the 90-day bank bill rate. Companies with a lower credit rating will have to pay a higher margin, just like a corporate bond. The rate can be fixed at a specific return, or it can ‘float’, meaning if the bank bill rate goes up or down, so too does the interest rate the investor receives. And hybrids commonly incorporate franking credits as part of the yield.

The rate a hybrid pays when it’s issued will normally be set by the issuer’s investment bankers going out to the market and testing investor appetite. Then once the security is trading on the market, the rate an investor receives will depend on the price they pay for the hybrid.

The part that makes hybrids complex and risky is the equity element. No two hybrids are the same, and the obligations of the issuer and the rights of the investor, can vary considerably. Some hybrids allow the issuer to stop paying any interest if it falls into financial difficulties, and some place the investor’s rights to recover their money in the event of the company failing behind all other creditors.

The theoretical price a hybrid security should trade at is determined by the combination of its starting margin over the bank bill rate, its different equity-type features and the length of time before it matures. The longer the time to maturity, the more time there is for something to go wrong and so the higher should be the interest rate.

The upshot of all these features is that hybrids are normally a lot more volatile than pure fixed income investments, but not as volatile as shares. When the ASX 200 fell 37% in February and March this year, the Betashares Active Hybrids ETF (HBRD) dropped by just over 15% and is now getting back to its pre-COVID levels, while the broader share market is still 14% below it.

Andrew Papageorgiou, a portfolio manager at credit investing fund manager Realm Investment House, said, “While hybrid prices do fluctuate, they are underpinned by solid mathematics. Like all securities, from time to time prices can be considerably above or below where we calculate they should be, which creates opportunities.”

This begs the question: if a self-directed investor doesn’t have access to the maths, how do they know when hybrids are cheap or expensive? The various stockbrokers that help sell new issues usually publish research showing the basic valuation measures, such as the current yield, and some of them may offer recommendations.

It’s worth bearing in mind, however, those brokers get paid commission to sell hybrid IPOs (an exception that was carved out from the recent reforms that saw LICs and LITs stop paying commissions), so there is an overarching question of conflicts of interest. There are other websites, such as, that publish tables as well. Papageorgiou says a very rough rule of thumb is that normally bank hybrids, which dominate the Australian market, should generally trade at a margin of about 3.2 to 3.3% over the bank bill rate.

A few years ago Australia’s bank regulator, APRA, introduced clauses into bank hybrids enabling them to stop interest being paid or even to compulsorily convert the hybrids into shares if the bank’s senior equity falls below certain levels. ASIC expressed great concern that investors wouldn’t understand the risks and that hybrids were being marketed as an alternative to term deposits. To be clear, buying a bank hybrid is nothing like placing a term deposit with the same bank. A term deposit is government guaranteed (up to $250,000) and its value doesn’t change on a day to day basis.

However, asset allocation consultant, Tim Farrelly, argues the kind of market events required to trigger the conversion clauses are so extreme, and APRA is sufficiently vigilant, that investors shouldn’t lose sleep buying a bank hybrid provided they are comfortable holding it until maturity. That way they can ignore the market volatility and enjoy the added yield of a defensive, investment grade security. If you don’t think you can stomach the potential for 15% drops in the defensive part of your portfolio, no matter how temporary, then don’t go there.

Want to find out more about your investment options and whether hybrids could work for you? Get in touch today.

What you need to know about fixed income

What you need to know about fixed income

This article appeared in the Australian Financial Review

Every interest rate cut is another turn of the screw for investors looking for a decent, low risk return. Many a risk averse investor is finding they’re no longer able to rely on cash or term deposits to generate a reasonable return, and are instead considering other fixed income alternatives, of which there is an almost bewildering range. As usual, however, for every extra percent of return you try to get, you have to accept higher risks, so to avoid nasty surprises, you need to understand what those risks are.

 The explosion in the number of fixed income managed funds, ETFs and LICs over the past couple of years has come as product providers sniffed an opportunity to meet the demand for income in a low interest rate environment. According to BetaShares, in F2019 more money went into fixed income ETFs than any other category, in fact, 60% more than Australian equities.

Investors need to be aware the name ‘fixed income’ covers an enormous range of products, and they come with an equally enormous range of risk. The last thing a risk-averse investor should be doing is dumping a bunch of money into the highest yielding fixed income product they can find, without knowing what they’re getting in to.

Here are some basics to help you understand what you’re buying:

  1. What is a bond?

A bond is a security that a government, or some other kind of entity like a company, issues that says ‘if you lend me $100 today, I’ll pay you an interest rate on that money (the yield), and every year I’ll pay you the coupon (the technical name for the amount of money paid, so if you have a $100 bond with a yield of 10%, the coupon will be $10) every year until the bond matures (it could be anything from 30 days to 100 years), and at the end of the bond’s life, I’ll give you your $100 back.’ It’s similar to a term deposit, except being a security, it can be bought and sold.

  1. A bond’s maturity is usually fixed

Most bonds, especially government bonds, will have a set maturity date. There are some perpetual securities but they’re few and far between.

  1. A bond’s yield will reflect the issuer’s credit worthiness

The less risk you’re taking to get your money back the less yield you’re going to receive. That can be reflected in an issuer’s credit rating from a company like Moody’s or Standard & Poor’s, but other factors also come into it. Interestingly, there are only 11 countries with a AAA credit rating from S&P, Australia being one of them, while the US’s rating is only AA+.

  1. Bond yields can be fixed or floating

A bond’s yield can either be ‘fixed’, meaning it will pay the same coupon until it matures, or ‘floating’, meaning the coupon will be above some kind of benchmark (like the Bank Bill Swap Rate or LIBOR) and will be reset to reflect that rate from time to time.

  1. Bond prices are not fixed

Bond prices can fluctuate, a lot. The average investor is almost certain not to buy an actual bond, but instead will invest in a fund or ETF, and it’s important to realise a fund’s unit price can jump around, depending on what kind of fixed income securities it invests in.

  1. What makes a bond’s price change?

There can be a number of factors, but the main influence is expected inflation. If the market thinks inflation is falling, as it has recently, it will happily accept a lower yield to compensate for the reduced risk of the value of any future payments being eroded by inflation. If a bond’s coupon is fixed, meaning a 5% bond will pay no more or no less than $5 per year for every $100 bond, then it’s the price you pay for the bond that will increase instead. This is where you end up with the what seems weird at first: as a bond’s yield goes down, its price goes up, but in fact, it’s exactly the same as shares: if a share price goes up, its dividend yield goes down.

  1. Duration risk: the bond price’s sensitivity to changes in yield

A bond’s ‘duration’ tells you how much the price should change when the yield changes. For example, according to JP Morgan, the Australian bond index has a duration of 5.4 years, which means if interest rates go up by 1%, the price should fall by 5.4% (and vice versa if rates go down).

That’s really important because the longer a bond’s life, in normal times the higher should the yield be, which appeals to income-oriented investors, who are normally more conservative. However, while a bond’s maturity and duration are not the same thing, the longer a bond’s life the more duration risk it has, and with interest rates already so low, there is heightened risk they could go back up, and even if that’s only by a little bit, those longer bonds could lose a fair bit of their value.

  1. Credit duration: the bond price’s sensitivity to changes in ‘credit spreads’

Bonds issued by a company will typically pay a yield premium to reflect the increased risk that you might not get your money back. That premium is normally calculated as a certain percentage above some kind of benchmark, like the 90-day bank bill rate, and the gap between the two is called the credit spread.

‘Credit duration’ measures how much the price of the bond will change if the credit spread changes; a bond with credit duration of 3 years will fall 3% if the credit spread goes up (widens) by 1%, and vice versa.

Bonds have had an extraordinary start to the year, with the benchmark Bloomberg Composite Index rising 6.5% to the end of June. But almost all that return is because bond yields have fallen, with the 10-year Australian government bond yield dropping a full percent to 1.32% to the end of June, and it’s now even lower at 1.09%.

In fact, bonds have been a great investment since the GFC as yields have plumbed record lows. If you’re going to invest in fixed income securities now, you are, in part, placing a bet that yields will continue to fall, which may or may not happen. For investors looking to replace term deposits, you just need to keep in mind that fixed income does not necessarily mean low-risk.

Inflation: nothing to see here folks

Inflation: nothing to see here folks

The post-GFC economic environment has been characterized by low inflation. Despite so-called money printing (quantitative easing) and record low interest rates, the general price level has stubbornly refused to run away on us, leaving central banks instead expressing more concern over the past few years about the risks of deflation.

Inflation is critically important for investors and financial markets: for those on a fixed income, rising prices means your standard of living declines; and inflation is like kryptonite for bond markets, forcing yields to rise, which in turn affects how all assets are valued. So when the annualised inflation rate around the world rose dramatically over the past nine months it rightly captured lots of attention (the US went from 0.8% to 2.7%, the Euro Area went from 0.2% to 2% and Australia went from 1% to 2.1%).

But there were pressures over the past year from rising commodity prices that are now starting to fall out of the system. The biggest of those is oil, where prices doubled between February and June last year, but have been flat since – see the chart below.

Crude oil prices over the past 12 months

Crude Oil


It’s a similar story across many of the commodity markets. That means in a couple of months, if commodity prices are still trending sideways, the inflationary effect of those dramatic year on year price rises will fall away.

However, it needs to be borne in mind there are many different components to the inflation data, commodities being just one of them. No fewer than four PhD’s at Deutsche Bank penned a joint article this week arguing that inflation is on its way back in the US and Europe. The main reason they point to is the very low unemployment rate in the US which is likely to lead to increasing wage growth. This is reflected in the chart below, which compares the “Non-Accelerating Inflation Rate of Unemployment” (NAIRU – a fancy word for full employment and a bit of a favourite amongst economists and central banks) to core inflation (which usually excludes the more volatile prices like energy and food).

In the past when unemployment got very low,
wages went up and took inflation with it

Core inflation


The simple premise is that as unemployment gets lower, wages tend to go up and takes inflation with it. That makes intuitive sense, and I’m reluctant to argue against that kind of collective intellectual fire power, but one thing I’d point out is that the ingredients in the economic pot are very different now compared with the 1960s and 1970s.

The Australian March quarter inflation data, which was released yesterday and came in at 0.5%, lifted the annual rate to 2.1%, just scraping in to the Reserve Bank’s targeted range of 2-3%. While a 5.7% rise in petrol prices was the main driver, a 13% jump in vegetable prices helped a lot too.

Again, it’s possible things like Cyclone Debbie will affect fruit and vegetable prices in the next quarter and keep the overall CPI elevated, or wages growth might suddenly turn a corner, but at the moment the trend is sideways at best, which probably means the Reserve Bank is under that much less pressure to change interest rates.

Fixed income 101 – part 2

Fixed income 101 – part 2

In response to client questions, we recently posted part 1 of this article, which looked at the basics of what is meant when people refer to fixed income investing: the securities, what affects their price and how they differ from shares. In this second part we look at why bonds enjoyed a 30 year bull market that many experts forecast will come to an end but why this giant asset class still has a role to play in a typical Australian investor’s portfolio.

A 30 year bull market coming to an end?


Yield on U.S. 30 Year Treasury Notes

Yield on U.S. 30 Year Treasury Notes

Source: IRESS This chart shows the yield of the U.S. long bond. Remember, the higher the yield, the lower the price, so as the yield has declined over the past 30 years, the price has risen. An extraordinary 30 year bull market.

Anybody who had a mortgage back in the early 1980s will remember it as a time of high inflation that was eventually squashed by very high interest rates. We pointed out last week that one of the major influences on bond pricing is the outlook for inflation: the higher it is, the higher the interest rate you’ll require before buying the bond, meaning the lower the price is that you are willing to pay.

Not long after Paul Volcker was appointed as the Chairman of the U.S. Federal Reserve in 1979 inflation peaked at 13.5% p.a. Bond investors had been in a world of pain for almost 20 years as prices reacted to the mayhem of the oil shocks, but after Volcker pushed U.S. cash rates to a peak of 20% in 1981, inflation was smashed. It dropped to 3.2% by 1983 and so began a 30 year bull market for bonds (see the chart above) as investors became convinced that central banks had discovered the secret to keeping the inflation genie in the bottle.

We’re now seeing a world where sovereign bond yields are at or very close to all-time lows, numbers that on the face of them seem like a crazy annual return to accept in exchange for lending money to a government for ten years: the U.S. 1.82%, Japan 0.22%, Germany 0.35%, and if you want a Swiss bond you have to pay them 0.28% p.a. for the privilege! Not surprisingly, almost every bond fund manager argues yields simply cannot go a whole lot lower, which is another way of saying they expect the bull market will come to an end sooner rather than later.


Can you still make money from fixed income?

In short, yes you can. There are many different kinds of bonds, from government to corporate, and you can be pretty much assured that somewhere in the world there are attractive returns being offered. Proper fixed income investments are exactly that: you know in advance exactly what your return will be if you hold the investment to maturity. And if you stick to very safe investments, like sovereign bonds from a reliable debtor, then you can feel very comfortable you will get your money back together with the promised coupons.

But right now you’d think to yourself: hang on, if I buy a ten year bond from the U.S. I’m getting paid 1.8% p.a., which barely covers inflation. As with any investment, it’s a question of how much return you require and the risk you are prepared to take on to increase that return. There are other bonds offering more like 5-6% p.a. For some lucky investors they are happy just to know their money is safe. The other trick, as always, is being able to find them.

Also, there’s a concept in bond investing called ‘duration’, which measures a bond’s sensitivity to changes in interest rates. You can deliberately target bonds that have lower sensitivity to interest rates, called lower duration, which means they will be less risky. The catch is, like all investments that are less risky, the offset is that they come with a lower return, being a lower interest rate.

Some fund managers are even able to make investments that benefit from rising interest rates, which is referred to as ‘going short duration’ (similar in concept to short selling shares – you sell them at a higher price and make a return by buying them back at a lower price).


Does fixed income have a role to play in an Australian investor’s portfolio?

Definitely! One of the classic arguments in favour of all portfolios having at least some exposure to bonds is that they have a low, sometimes negative, correlation to equities. That is, when equities markets go down, bond markets can go up (see the chart below).


Calendar year returns for Australian equities and bonds
(from 31 December 1989 to 31 December 2011)

alendar year returns for Australian equities and bonds

Source UBS, IRESS, Vanguard


As we’ve argued many times, it’s next to impossible to predict on a short-term basis which asset classes will do well from one year to the next, but over the long-term you can confidently point to expected returns from particular asset classes. Having diversification in a portfolio is one of the simplest insurance policies you can get.

Another reason is that bonds pay a regular income stream, which for some investors can be exactly what is needed. The chart below shows the total return of bonds compared to shares over a 15 year period, and also shows how much of that return comes from income versus capital growth.


Components of total return 1997-2012

Components of total return 1997-2012

Source: Vanguard

Finally, a portfolio with a blend of equities and bonds can see a reduction in volatility without severely impacting returns.


Asset class and portfolio investment performance

Asset class and portfolio investment performance

Source: S&P, UBS, Vanguard

Experts have been calling the end of the bond bull market now for several years and at some point they’ll be right. But given the sheer size of the asset class, the contribution it can make to portfolios and the variety of securities to invest in, it should not be ignored.