Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 281

Floating rate bonds rise in popularity

Today’s market poses a conundrum for bond investors. On the one hand, volatility stemming from rising trade tensions, and China’s slowing growth, are driving investors towards bonds as a traditional portfolio shelter. On the other hand, central banks around the world are tightening policy and conventional investment wisdom dictates that bonds do not perform well in a rising rate environment. What many investors are missing out on is the fact that floating rate bonds allow both portfolio protection and consistent returns. They can minimise the impact of rising rates on a bond portfolio. Interest rate risk is almost non-existent and the bonds are typically more capital stable. Citi has seen a five-fold increase in year-to-date investment in floating rate bonds by investors compared to the same period over 2017.

Investors are attracted to this asset class as floating rate bonds offer investors the inherent advantages of bonds, such as regular income and portfolio shelter in time of market stress, while also benefitting from rising rates. However, many investors have not heard of floating rate bonds and therefore have not included them in their portfolio.

Accessing floating rate bonds

Individual floating rate bonds typically are not accessible to many 'retail' investors due to regulatory restrictions. At Citi, only 'wholesale' investors have access. To be defined as a wholesale investor, a client needs a qualified accountant’s certificate stating they have net assets of at least $2.5 million, or a gross income for each of the last two financial years of at least $250,000.

Certified clients can access products that may be country specific or a multinational corporate giving exposure to a thematic like renewables or communications.

There are a few other ways that investors can access these investment benefits, including via ASX-listed floating rate ETFs and bonds, exchange-traded bonds issued by companies like XTB, and unlisted funds. Listed floating rate bonds provide an option for retail investors but they do not cover the wide range of borrowers available in the unlisted market. Wholesale investors can access traditional floating rate bonds by tapping into a global reach and a larger offering with potentially more attractive yields. Some other brokers allow access to certain bonds in 'retail' parcels.

How they work

Floating rate bonds pay a coupon that resets periodically and is based on a benchmark short-term interest rate index. For USD bonds, the regular coupon paid to investors is typically the 3-month Libor (London Interbank Offered Rate) plus a spread premium. For example, the coupon can be set at 3-month Libor + 2%. At current levels this would mean the investor earns 4.33% which is as compelling as most fixed rate bonds.

Typically, investors cite three main reasons for choosing floating rate bonds:

  • Short-term interest rates are expected to rise
  • As alternatives to term deposits for higher levels of income
  • To avoid the risk in fixed rate bonds of the bond’s price declining when interest rates move up

Rising popularity

Recently, purchases of both USD-denominated and AUD-denominated floating rate bonds have increased significantly. Investors are riding the Fed’s rate hiking cycle and are benefiting from expectations of higher short-term rates. The 3-month US Libor is now at its highest since 2008 and some economists expect the US benchmark to near 3.5% by the end of 2019.

Domestically, even though the RBA currently remains on hold, our economists consider the central bank maintains the view that the next move in interest rates is likely to be up.

As demand from investors for floating rate bonds has grown, supply has followed with strong creditworthy issuers offering a smorgasbord of choice. Floating rate bond issuances in USD-denominated and AUD-denominated have increased significantly in 2018.

These two bonds are examples that illustrate this point:

  • Barclays PLC issued a 5-year floating rate bond with a current coupon close to 4% that will increase as the Australian benchmark rate, the 90-day BBSW, increases.
  • China’s Far East Horizon offers a spread of 2% over the 3-month US Libor for 3 years.

While these two bonds have been the most popular with our clients in 2018 to date, each customer should consider their own needs and circumstances before deciding to invest.

With the market having priced one more Fed hike for 2018 and with the growing likelihood of a second one, investors look likely to continue turning to floating rate notes for both portfolio protection and consistent returns.

 

Elsa Ouattara is a fixed income strategist at Citi Australia. This article is for general information only and does not consider the specific circumstances of any individual.

 

RELATED ARTICLES

Central banks risk losing their feted ‘independence’

Five reasons Australian rates unlikely to follow US

Volatility and reflecting on the inflection

4 Comments
Guy Brindley
November 23, 2018

It would have been useful to know how you access the two bonds listed and whether they are accessible to retail investors. If so code etc
Googling doesn't come up with anything or looking at ASX etc

Graham Hand
November 23, 2018

Hi Guy, the two bonds mentioned are not listed on the ASX. The article uses them to illustrate the types of bonds available via a 'broker'. Some fixed interest brokers (such as Mint Securities, soon to be BGC, and FIIG) allow access to retail parcels of unlisted bonds, but as the article says, there are many more bonds available to larger investors.

Warren Bird
November 23, 2018

"There are many more bonds available to larger investors." Which is how retail investors should access them, via managed funds. Hobby horse of mine, I know, but floating rate notes involve credit risk and to manage credit risk properly you not only have to do detailed credit risk analysis on each bond issuer, but also put together a highly diversified portfolio. That is, hundreds of issuers. Managed funds come into their own for providing that.

Certainly , retail investors should not buy just two securities! Or 10, or 20 like some brokers recommend. You need to make sure that if 1 or 2 go south, it doesn't wipe you out. So you want no more, usually, than 1% of your credit portfolio in any one name, especially if you're not in the position to do on-going credit research.

Pat
November 22, 2018

You only mention XTB and ETF's regarding the purchase of bonds where as there are other avenues such as through fixed interest brokers directly. Both Wholesale and Retail investors can invest through several brokers and they provide extensive research and updates on companies and bonds available, you also have access to FRN, FCN, IAB's, RMBS. I think an article like this should be more transparent and not push only items that Citi Australia trade.


 

Leave a Comment:

     
banner

Most viewed in recent weeks

Responses to the 'OK Boomer' poll

While every generation has its unique opportunities, the majority of Firstlinks readers agree that Boomers have had a better run than others. But the real highlights here are in the comments.

How to make money at the end of a bull market

It's been a strong year for the stockmarket, and a good decade since the end of the GFC. However, there are signs the bull will stop running soon, and portfolios should be positioned in advance.

Robert Merton on retirement incomes and Jane Austen

1997 Nobel Laureate Robert Merton wants greater focus on the income that will sustain a retirement, and even Jane Austen understood this. And he has a surprising proposal to help with longevity risk.

Nest and nest egg: 23 aspects of housing and ageing

The family home is the biggest asset of most Australians across all age groups, and its role as both a place to live and an investment makes home ownership the biggest retirement policy issue.

Uncharted waters, 2020 and beyond

As we approach the 2020s, we are sailing into uncertain waters at best. These times also have some historical precedents, but we need to make important reforms before our luck runs out.

Peter Meany on global trends in infrastructure assets

A global portfolio of infrastructure assets allows trends in one part of the world to be recognised early in another, while companies with pricing power and high barriers to entry enjoy extra resilience.  

Latest Updates

Sorry, there’s no real place to hide

Billions of dollars of personal savings are flowing into 'fixed interest' funds, but do investors understand the risks? These funds have a place but they are not a short-term haven for worried retirees.

Investment strategies

20 favourite investment and life lesson quotes

Favourite quotations from famous people on markets, investing, processes, noise, pessimism, self perception and life balance. These lessons carry across investment cycles and lifetimes.   

Financial planning

We need national and personal visions for retirement

Two different articles cover a recent report on the attitudes of Australians towards retirement. What should be a enjoyable life stage is feared by many, and they fail to plan and work towards it.

Shares

Beware: the share valuations failing the commonsense test

The valuation maths of many expensive companies simply cannot work. They assume low interest rates for long terms, but strong economic growth to drive ongoing success. You can't have both. 

SMSF strategies

SMSFs the new battleground in family disputes

With the best will in the world, family disputes often occur on the death of a family member. SMSFs often hold substantial assets, and the role of trustees and death benefit nominations is tricky.  

Sponsors

Alliances

Special eBooks

Specially-selected collections of the best articles 

Read more

Pandora Archive

Firstlinks articles are collected in Pandora, Australia's national archive.

Read more