Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 123

Listed bonds finally reach retail investors

It has always been an anomaly of the Australian financial system that retail investors have not had ready access to high quality corporate bonds. In most developed markets, and particularly in Europe, bonds have long been the mainstay of retail portfolios. At last in Australia, 17 corporate names are available through Exchange-Traded Bonds or XTBs listed on the ASX, to be purchased in the same way as any listed security.

In a prior life, I spent many years doing roadshows around Europe marketing bonds destined for retail investors. It was great fun. For the first ever transaction exceeding $A100 million in the Euromarket denominated in Australian dollars, we flew around Switzerland (with the light plane banking around the snow-capped Matterhorn!) visiting private banks who gobbled up the generous coupons for their Belgian dentist customers. It was wood-panelled meeting rooms inside splendid granite buildings, with polite Swiss bankers taking generous fees for keeping their clients happy.

But none of the bonds we issued in Australia were intended for retail distribution. The banks had the term deposit market sewn up.

Investors taking equity risk to achieve returns

Australian retail investors looking for secure yield have never been significant buyers of government bonds, except indirectly through bond funds, and now, ETFs based on bonds. Until recently, when fixed interest specialists like FIIG Securities started bringing corporate names to the market, retail investors were limited to bank term deposits and a few bonds listed on the ASX.

This might have been acceptable when interest rates were higher (Westpac issued a five-year term deposit paying 8% as recently at 2010), but the current bank rate for a five-year term deposit is only about 3%, barely covering inflation. Investors have turned to the much higher risk of shares, where the volatility of the All Ords index at about 15% is over three times the bond index. This is not a satisfactory solution to the problem of capital stability, as many investors have realised with the shock of bank shares like CBA falling from $96 to below $80 in a few months. That’s three years of dividends gone.

Need to open corporate bond market

Little wonder that the Financial System Inquiry Final Report argued that: “Less onerous disclosure requirements for listed securities would make retail issuance simpler and more cost effective” (page 263) and called for regulations to change to improve access to the bond market for retail investors.

As a sign of the need for secure alternatives, the latest ATO data for March 2015 shows 26.5% ($157.4 billion) of SMSF investments sitting in cash or term deposits, at a time when the cash rate is only 2%. Not many retirement goals are being met at that rate. Only $5 billion is listed under ‘debt securities’, although this ignores bond funds. Institutional super funds hold between 10% and 30% of their balanced options in fixed interest.

Australian Corporate Bond Fund (ACBC) has found a solution to the structural problem by placing individual senior, unsecured wholesale bonds into a trust, which issues ASX-listed securities called XTBs, similar to managed funds or Exchange Traded Funds. Each XTB reflects the maturity and coupon of the underlying corporate bond, best illustrated with an example:

  • ASX code YTMLLC gives exposure to a Lend Lease Corporation (LLC) senior bond
  • Final maturity is 13 November 2018
  • Coupon is 5.5% pa paid semi-annually
  • As at 19 August 2015, offered on the ASX at a price of $107.83.

Australian investors think in terms of yield, not price, and the XTB website has a useful calculator. Plugging in these numbers gives a yield to maturity of 3.39% at the time of writing (19 August 2015).

On the current range of XTBs, a fee of 0.4% per year to maturity is charged in the price by the manager, meaning the XTB investor receives 0.4% lower yield than wholesale. ASIC is in process of approving 16 more XTBs including five using floating rate senior bonds. It is expected that the fee structure for the floaters will be materially lower, to offer investors a more competitive option to cash or rolling short term deposits.

Table 1 shows the range of 17 bonds available at the moment.

Table 1: Corporate bonds available through XTB as at 19 August 2015

GH Figure1 210815

GH Figure1 210815

What are the issues to consider for retail investors?

The most obvious point is that these names are all high quality, investment grade issuers, so none of the indicative yields are above 4%. Many of the bond transactions brought to the market by FIIG are unrated and sub-investment grade, but this is what is required to achieve the higher yields of over 6.5%. Retail investors chasing these returns need to carefully consider whether unrated issuers are worth the extra risk, and ensure a wide diversity without a large exposure to any one name. Companies with ratings below the investment grade of BBB+ have an exponential risk/return trade off, as shown in Figure 1.

Figure 1: Five-year probability of default by credit rating.

GH Figure2 210815While XTB is in the ideal space for investors looking for better security and uncomfortable with equity risk, demand would have been much higher five years ago when rates were higher. Investor appetite for Telstra at 2.79%, Wesfarmers at 2.9% and Woolworths at 3% will be subdued while the major bank deposits are at or around 3%. This is despite the banks calling off their ‘term deposit war’ which created attractive rates when they were intent on building their retail funding bases. While there’s an argument for diversifying away from bank risk for hybrids and shares, bank deposits carry a government guarantee up to $250,000 and the familiarity of the term deposit structure.

However, for the conservative investor looking for senior debt of quality corporate names, who is not keen on bond funds and the riskier hybrids, it’s worth considering a bond such as Lend Lease at 3.8% for five years. All bonds must be ‘seasoned’ for at least a year in the wholesale market for ASIC to allow the product to be offered as an XTB, which ensures there has been good price discovery.

Another advantage of XTBs is their access point via the ASX. Along with developments such as mFunds, over 100 ETFs, actively-managed listed funds and even private equity funds, investors such as SMSFs can implement a diversified portfolio directly on the exchange through their broker, without the need for a separate platform.

What are the downsides? Clearly, as with any bond, XTBs are tied to the performance of the underlying bond. Investors should consider Figure 1 and recognise that although these bonds are senior debt, they are not immune from the vicissitudes of corporate fortune.

The market-making role at the moment is carried out by Deutsche Bank, and liquidity has not been tested in the new structure. Although ACBC was established in 2013 and is the only company currently using this structure for bonds, its executives have significant fixed interest experience.

In summary, XTBs are a welcome addition to the supply of corporate bonds for the retail investor, and worth considering for those who want far less volatility in the value of their capital, while giving a reasonable income flow in the current low rate environment. Unlike a bond fund, the investor knows exactly what they own and when it matures.

 

Graham Hand is Editor of Cuffelinks. This article is for general education purposes and does not consider the circumstances of any investor.

RELATED ARTICLES

Four reasons ESG investing continues to grow

Don't invest just for yield: the smarter way to generate income

Where to put your money these days

banner

Most viewed in recent weeks

Unexpected results in our retirement income survey

Who knew? With some surprise results, the Government is on unexpected firm ground in asking people to draw on all their assets in retirement, although the comments show what feisty and informed readers we have.

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Six COVID opportunist stocks prospering in adversity

Some high-quality companies have emerged even stronger since the onset of COVID and are well placed for outperformance. We call these the ‘COVID Opportunists’ as they are now dominating their specific sectors.

Latest Updates

Retirement

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Interviews

Sean Fenton on marching to your own investment tune

Is it more difficult to find stocks to short in a rising market? What impact has central bank dominance had over stock selection? How do you combine income and growth in a portfolio? Where are the opportunities?

Compliance

D’oh! DDO rules turn some funds into a punching bag

The Design and Distribution Obligations (DDO) come into effect in two weeks. They will change the way banks promote products, force some small funds to close to new members and push issues into the listed space.

Shares

Dividends, disruption and star performers in FY21 wrap

Company results in FY21 were generally good with some standout results from those thriving in tough conditions. We highlight the companies that delivered some of the best results and our future  expectations.

Fixed interest

Coles no longer happy with the status quo

It used to be Down, Down for prices but the new status quo is Down Down for emissions. Until now, the realm of ESG has been mainly fund managers as 'responsible investors', but companies are now pushing credentials.

Investment strategies

Seven factors driving growth in Managed Accounts

As Managed Accounts surge through $100 billion for the first time, the line between retail, wholesale and institutional capabilities and portfolios continues to blur. Lower costs help with best interest duties.

Retirement

Reader Survey: home values in age pension asset test

Read our article on the family home in the age pension test, with the RBA Governor putting the onus on social security to address house prices and the OECD calling out wealthy pensioners. What is your view?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.