CORPFIN 7040: Fixed Income Securities (M)

Embedded Research Project

Hejie Tong a1728585

Yuan Deng a1806791
Longchen Zhang a1813625
Xiaoyi Guo. a1759811

Word Count: 2509

Introduction
Bond funds are the investment funds managed professionally that invest solely in the bonds,
whether government bonds or corporate bonds. These funds pay periodic dividends and
interest payments as well as capital appreciation over the investment period [ CITATION
Don17 \l 16393 ]. The report is based on the analysis of four investment funds which are
involved in investing in the bonds which are professionally managed. The four funds are
Vanguard Australian Fixed Interest Index Fund, Vanguard Australian Inflation-Linked Bond
Index Fund, PIMCO Australia Global Bond Fund, and PIMCO Australia Income Fund. All
the four funds will be analyzed in this report on the basis of different aspects including
certain performance measures as well. On the basis of this analysis, one fund will be selected
for the purpose of investment. Lastly, a portfolio of all the four funds will also be created by
giving the appropriate weightage to each fund in the portfolio.
(Word Count: 153)

Vanguard Australian Fixed Interest Index Fund

The first portfolio is Vanguard Australian Fixed Interest Index Fund whose benchmark index
is Bloomberg AusBond Composite 0+ Yr Index, i.e., tracks the performance of this index.
The yield to maturity of this fund is 1.11% while the effective duration is 6 years. The
management fees charged by the fund is 0.24% per annum [ CITATION Van211 \l 16393 ].
The number of bonds held by Vanguard Australian Fixed Interest Index Fund are 615 while
those held by the index are 690. The buy/ sell spread cost of the fund is 0.08%/ 0.08%. The
graph below showcases the monthly returns of the fund since its inception date. The graph
showcases numerous ups and downs over the period while there is a recent severe downfall
which shows the least monthly return, i.e., the worst performance during the life of the fund.
The downfall was witnessed by the end of February 2021. The recent downfall in the return
of the fund has been due to the downgrade of fund by research house Lonsec [ CITATION
Ale21 \l 16393 ]. The analyst downgraded the fund owing to its high management fees
despite being a passive fund and less transparency.
The blue dots showcase the outliers which fall outside -1.30% and 2.15%.

The buy/ sell spread is the cost of transaction incurred when buying or selling the security.
This spread is charged to the investors. The net assets value of a fund showcases its market
value per unit. This value is computed by dividing the total value of assets invested in the
fund minus the liabilities owed, by the total number of units. There are different types of
bonds in which a fund can invest and form a portfolio. These include Treasury, Government-
Related Sovereign; Government-Related Agency; Government-Related Supranational;
Corporate-Financial Institutions; Corporate-Industrial; Government-Related Local Authority;
Corporate-Utility; Securitized-Covered. These can be categorized into government bonds and
corporate bonds. The government bonds are issued by the government of a country while
corporate bonds are issued by the companies for raising funds. Vanguard Australian Fixed
Interest Index Fund invests in 615 different types of bonds as named above and with different
maturities. The maturities vary from 1 year to more than 20 years. Using the holdings of the
fund and the zero-coupon yield curve obtained from Reserve Bank of Australia (2021), the
duration of overall portfolio has been computed which is estimated to be 5.301 years.
Overall, the fund has earned 0.42% on an average which is quite low and hence, the
performance can be said to be less satisfactory.
(Word Count: 420)

Vanguard Australian Inflation-Linked Bond Index Fund

The second portfolio for the purpose of this report is Vanguard Australian Inflation-Linked
Bond Index Fund whose benchmark index is Bloomberg AusBond Inflation Treasury 1+ Yr
Index. The index fund invests in the inflation-linked bonds which are issued by the
Commonwealth Government of India. The effective duration for the fund is 10.2 years and
the management fees charged by the fund is 0.29% per annum [ CITATION Van212 \l 16393
]. The fund holds investment in 7 different bonds and the buy/ sell spread is 0.1% / 0.1%. In
order to test the returns and performance of the fund since the date of its inception, the total
monthly returns have been considered. Using these returns, the following metrics have been
computed.
 Fund Returns
8.00%

6.00%

4.00%

2.00%

0.00%
2 2 3 3 4 4 4 5 5 6 6 6 7 7 8 8 9 9 9 0 0 1
- 1 - 1 - 1 - 1 - 1 - 1 -1 - 1 - 1 - 1 - 1 - 1 - 1 - 1 - 1 -1 - 1 - 1 - 1 - 2 - 2 - 2
ay Oct ar Aug Jan Jun Nov Apr Sep Feb Jul Dec ay Oct ar Aug Jan Jun Nov Apr Sep Feb
-2.00%
M M M M
-4.00%

-6.00%

-8.00%

Recently, the returns of the fund have fallen around February 2021 as can be seen in the
graph above. Similar to the previous fund examined, this fund also showcases similar reasons
for this downfall of the returns. The management fees of the fund as well as the buy and sell
spread of this fund is even higher due to which the fund has downgraded in the recent period
[ CITATION Ale21 \l 16393 ]. The graph also shows that there was a significant fall in the
returns of the bond in March 2020 also. The whole market, including the index funds, was
impacted during that period owing to the COVID-19 pandemic. The table below indicates the
maturity of each indexed bond in which the index fund invests.

Holding Name Rate Maturity Date

Australia Government Bond 3% 20 Sep 2025
Australia Government Bond 2.50% 20 Sep 2030
Australia Government Bond 0.75% 21 Nov 2027
Australia Government Bond 2% 21 Aug 2035
Australia Government Bond 1.25% 21 Aug 2040
Australia Government Bond 1% 21 Feb 2050

After collecting the data of above listed indexed bonds, the duration of the fund’s portfolio
has been estimated. The portfolio duration is estimated to be -9.4295 years. The overall
performance of the fund in comparison to the performance of benchmark index is shown
using the chart below.
The chart showcases that in almost all the periods, except in 1 year returns, the gross returns
of the fund are slightly higher than those of the benchmark. This describes that the fund has
outperformed the benchmark in most of the periods. However, the average return of the fund
since its inception is only 0.32% which is very low with 1.59% of the risk involved.
(Word Count: 405)

Actively Managed Funds by PIMCO

PIMCO Australia Global Bond Fund is an actively managed fund with the benchmark
index, Bloomberg Barclays Global Aggregate Index hedged into AUD. The yield to maturity
of the fund is 1.94% and the effective duration is 6.92 years. The management fee for the
fund is charged at the rate of 0.49% [ CITATION PIM21 \l 16393 ]. In order to summarize
the performance of the fund since its inception, the fund fact sheet has been considered
according to which, the following annual returns have been computed along with certain
performance metrics such as average return, standard deviation, etc.
From the above data, it can be seen that the recent performance of the fund(3.93%) has been
relatively poor. However, the performance since inception is relatively high compared with
benchmark index as shown in the graph below.

PIMCO Australia Global Bond Fund invested in high-quality, developed countries around the
world, i.e., in the U.S., U.K., Japan, and Europe etc. The contributors of the active positions
are:
 Overweight to senior and subordinate financials
 Underweight to duration in the Eurozone
 Long exposure to select dollar block currencies
The detractors of these active positions to fund performance are:
  Positions in EM external debt
 Preference for duration in Eurozone peripherals, specifically Italy
 Local rate exposure in select EM countries, specifically Peru
These active positions maintain a modest overweight to duration in the U.S. and a cautious
portfolio based on grade corporate credit and also modestly short the U.S. dollar in
currencies. PIMCO Australia Global Bond Fund remain focused on portfolio positioning,
capital preservation, and liquidity management, thus in the future they choose to hold
underweight duration stocks as a hedge against a potential inflation and invest in safe
companies around the world within corporate credit.
The return to risk ratio of this fund is estimated by dividing the average return by the standard
deviation which has been estimated to be 2.17. This implies that for every unit of risk taken,
the return earned by the fund will be 2.17% which is an acceptable risk-reward trade-off.
PIMCO Australia Income Fund is a fund with the benchmark index, Bloomberg Barclays
Global Aggregate Index hedged into AUD. The yield to maturity of the fund is 3.71% and the
effective duration is 2.31 years. The management fee for the fund is charged at the rate of
0.78% [ CITATION PIM211 \l 16393 ]. In order to summarize the performance of the fund
since its inception, similar performance metrics from above such as average return, standard
deviation, etc. has been evaluated.

From the above data, it can be seen that the recent performance of the fund has been
relatively poor. However, this performance since inception is higher than the benchmark
returns as can be seen in the following graph.
The income fund targets high, consistent income and it takes a broad-based approach to
investing in income-generating bonds. The fund is divided into higher yielding assets
weighted towards senior debts and higher quality assets to face high inflation. The
contributors of taken active positions are:
 Long exposure to U.S. duration
 Long exposure to investment grade corporate and high yield credit
 Long exposure to emerging market currencies
 Holdings of securitized credit, including agency and non-agency MBS
The detractor of taken active positions is:
 Modest long exposure to Italian duration, as yields increased.
In the future, PIMCO Income Fund remain focused on diversification and stay senior in the
capital structure. However, some price volatility and the challenges of defaults may appear.
The return to risk ratio of this fund is estimated by dividing the average return by the standard
deviation which has been estimated to be 0.87. This implies that for every unit of risk taken,
the return earned by the fund will be 0.87% which is not an acceptable risk-reward trade-off
as is extremely low.
(Word Count: 629)

Selection of Portfolio
The objective of Vanguard Australian Fixed Interest Index Fund is to provide protection
against the capital volatility, while that of Vanguard Australian Inflation-Linked Bond Index
Fund is to provide the investors with a stable income stream and also to secure the capital
from long-term impact of inflation. The objective of PIMCO Australia Global Bond Fund is
to preserve the capital while that of PIMCO Australia Income Fund is to provide a consistent
income stream as well as capital appreciation. The main objective to invest in the bond
market should be capital appreciation since, the investment is aimed at long-term investment
horizon. Thus, based on this objective, all the four funds are eligible for investment. Further,
while investing in an investment fund, it is important to understand the different types of risks
to which the fund is exposed. These risks may include interest rate risk, liquidity risk, credit
risk, and inflation risk. The protection towards inflation risk is provided only in the second
fund, i.e., Vanguard Australian Inflation-Linked Bond Index Fund, while the other type of
risks is attempted to be protected by all the other funds as well. Thus, in this regard, the
Vanguard Australian Inflation-Linked Bond Index Fund shall be most suited for forming a
portfolio.
Further, on the basis of the past performance also, the fund can be chosen for investment, i.e.,
the fund that has provided the highest risk adjusted return over the past since its inception.
The computation of annual returns and the return to risk ratio has been shown in the table
below for each of the four funds.

The above table showcases the performance metrics of the funds. The average return of
PIMCO Australia Global Bond Fund is the highest over the past years while that of the
Vanguard Australian Inflation-Linked Bond Index Fund is the lowest. The standard
deviation, i.e., the risk is highest in PIMCO Australia Income Fund and is lowest in PIMCO
Australia Global Bond Fund. This shows that PIMCO Australia Global Bond Fund has the
highest average return but lowest risk involved. This makes the fund most suitable for the
investment. Moreover, the return to risk ratio is also highest for PIMCO Australia Global
Bond Fund which implies that this fund shall earn the highest return per unit of risk taken.
Therefore, based on the complete discussion above, it can be said that PIMCO Australia
Global Bond Fund is the most appropriate fund for investment out of all the four funds
considered in this report.
On the other hand, if a portfolio of all the four funds is to be made, then the weights shall be
given on the basis of return to risk ratio computed above which showcases the risk-adjusted
measure of fund’s performance. From the analysis above, it has been seen that the highest
return to risk ratio is of PIMCO Australia Global Bond Fund which implies that the highest
weightage in the portfolio shall be given to this fund. Secondly, the Vanguard Australian
Inflation-Linked Bond Index Fund shall also be given a considerable weightage so as to get
protection for the inflation risk in the economy, as this is the only inflation-linked fund
among all the four funds analysed. Furthermore, Vanguard Australian Fixed Interest Index
Fund provides protection against capital volatility and hence, this fund can also be given
small weightage in the portfolio. However, PIMCO Australia Income Fund will not be given
any weightage in the portfolio since, it has earned the lowest return at highest risk over the
past since its inception. Thus, the final weights of the portfolio shall be as follows:
Fund Weightage
Vanguard Australian Fixed Interest Index Fund 10%
Vanguard Australian Inflation-Linked Bond Index Fund 20%
PIMCO Australia Global Bond Fund 70%
PIMCO Australia Income Fund 0%
(Word Count: 629)

Conclusion
The report was based on analyzing four investment funds with respect to different measures
such as benchmark index, objective, management fees, buy/ sell spread, effective duration,
etc. The four funds under consideration were Vanguard Australian Fixed Interest Index Fund,
Vanguard Australian Inflation-Linked Bond Index Fund, PIMCO Australia Global Bond
Fund, and PIMCO Australia Income Fund. The duration of the first two funds were computed
using the weights of bonds in the fund and yields in the economy. Further, the returns were
also analyzed for all the four funds, monthly returns for the first two funds and annual returns
for the next two funds. Further, the complete comparison of all the four funds was done on
the basis of average annual return of the funds since inception, standard deviation, return to
risk ratio, etc. From the analysis, it could be seen that PIMCO Australia Global Bond Fund
has performed the best over the past with the highest average return and lowest standard
deviation, while PIMCO Australia Income Fund has performed the worst with the low
average return and highest standard deviation. On this basis and considering the objective of
the investors, the PIMCO Australia Global Bond Fund has been selected to be the best
available fund for investment. Moreover, a portfolio of all the four funds has also been
created whereby the PIMCO Australia Global Bond Fund is given the highest weightage
followed by Vanguard Australian Inflation-Linked Bond Index Fund, and Vanguard
Australian Fixed Interest Index Fund, while the fourth fund is not included in the portfolio.
(Word Count: 257)
References
Bennyhoff, D. G., Donaldson, S. J., Dunlap, J. & Roberts, D. R., 2017. A topic of current
interest: Bonds or bond funds?, s.l.: Vanguard.
PIMCO, 2021. Global Bond Fund. [Online]
Available at: https://www.pimco.com.au/en-au/investments/australia/global-bond-
fund/wholesale
[Accessed 18 May 2021].
PIMCO, 2021. Income Fund. [Online]
Available at: https://www.pimco.com.au/en-au/investments/australia/income-fund/wholesale
[Accessed 18 May 2021].
Reserve Bank of Australia, 2021. Statistical Tables. [Online]
Available at: https://www.rba.gov.au/statistics/tables/#interest-rates
[Accessed 25 May 2021].
Vanguard, 2021. Vanguard Australian Fixed Interest Index Fund. [Online]
Available at: https://www.vanguard.com.au/personal/products/en/detail/8103/performance
[Accessed 23 May 2021].
Vanguard, 2021. Vanguard Australian Inflation-Linked Bond Index Fund. [Online]
Available at:
https://www.vanguard.com.au/institutional/products/en/detail/wholesale/8137/bond
[Accessed 15 May 2021].
Vickovich, A., 2021. Vanguard’s $9b fixed income fund downgraded. [Online]
Available at: https://www.afr.com/companies/financial-services/vanguard-s-9b-fixed-income-
fund-downgraded-20210414-p57j87
[Accessed 28 May 2021].