How the Bloomberg AusBond Bank Bill Index Makes Negative Returns

The most common benchmark for money market products and conservative investors in Australia is the Bloomberg AusBond Bank Bill Index (Index).   This Index consists of 13 synthetic 91 day maturity bank bills issued on successive Tuesdays at the then current 3 month bank bill rate.  When one bank bill matures after 91 days (13 * 7 days), the funds are nominally re-invested in a new 91 day bank bill at the prevailing 3 month interest rate. As a result, the index value compounds over time (assuming interest rates are positive).  However, because the index value is the sum of the “mark to market” value of the individual synthetic bank bills being the redemption amount of each of the 13 index bank bills discounted at the prevailing interest rate applicable to the number of days each bill has before maturity, there are fluctuations in the index value day to day or month to month.

To illustrate this point using a simplified example, if the index contains nothing but 3 month bank bills issued with an interest rate of 0.01% (as was broadly the case at the end of February 2021; BBSW rates having been steady at around 0.01% for the previous three months), then if $1,000,000 was invested in each of the 13 bank bills comprising the index, each bank bill would have a redemption value of $1,000,025 (i.e. it would earn interest of $25 over a 3 month period if the annual interest rate was 0.01% with this interest being added to the principal invested to comprise the redemption amount). 

If interest rates rise from 0.01% to 0.03%, the bank bill that matures in 3 months’ time at a value of $1,000,025 will have a “mark to market” value of $1,000,025 / (1+ (0.03% * 3/12)) = $999,950 (i.e. less than the purchase price of $1,000,000).  The bank bill that matures in two months’ time will have a “mark to market” value of $1,000,025 / (1+ (0.03% * 2/12)) = $999,975, the bank bill with 1 month to maturity will have a “mark to market” value of $1,000,025 / (1+ (0.03% * 1/12)) = $1,000,000 and the bank bill with no time to maturity will be valued at $1,000,025 (its redemption amount). All other bank bills in the index will have values between these quoted above in proportion to their time to maturity.

With an even spread of 13 bank bills across the 91 days of the month, the average time to maturity of the bills in the Index is around 1.5 months which places the average bank bill value at $1,000,025 / (1+ (0.03% * 1.5/12)) = $999,988 (i.e. less than the initial investment of $1,000,000 in each bank bill). This means the Index value has declined from the prior month or the time of purchase when the average bill was valued at its initial value. Note in this calculation, it is the relative rise in interest rates that is important and while moving from an interest rate of 0.01% to 0.03% (which is broadly what occurred in February 2021) sounds like only a 0.02% move, it is actually a tripling of the interest rate. It is this very large relative increase in interest rates that caused the Index to record a negative return in February 2021.

The true calculation is more complex than the simplified illustration above as all the bank bills in the Index will have slightly different interest rates (not 0.01%) depending on the prevailing interest rate when they were issued and will be discounted at the interpolated rate applicable to the number of days to maturity (not a constant rate of 0.03%). The actual results were the Index value went from 9,020.22 at the end of January to 9,020.18 at the end of February for a (9,020.18 – 9,020.22) / 9,020.22 = -0.000443% fall across the month; the first negative return ever. 

In March, the Index return was positive being around 0.0019% as market movements were not so (relatively) pronounced. However the Index could provide negative returns again if interest rates were to rise. The fundamental “problem” is interest rates are so low the running yield on the Index (which is always positive so long as the interest rate on the bank bills remains positive) is susceptible to being swamped by capital gains and losses which are caused by changes in interest rates that are small in absolute terms (say 2bps), but large in relative terms (a tripling of rates from 1bp to 3bps).

This effect could also cause some cash funds to produce negative returns going forward. This was the case with the NSW TCorp Cash Fund in March 2020 when there was a sudden movement in interest rates, however since then the fund has altered its mix of investments. Cash funds can prevent negative returns if they invest predominantly in bank bills of even shorter duration than those included in the bank bill index as above so long as those bank bills have positive yields. However, the trade-off is with interest rates so low, returns will be even more meager.

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