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.

 

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:

     

RELATED ARTICLES

Central banks risk losing their feted ‘independence’

Five reasons Australian rates unlikely to follow US

Volatility and reflecting on the inflection

banner

Most viewed in recent weeks

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Noel's share winners and loser plus budget reality check

Among the share success stories is a poor personal experience as Telstra's service needs improving. Plus why the new budget announcements on downsizing and buying a home don't deserve the super hype.

Grantham interview on the coming day of reckoning

Jeremy Grantham has seen it all before, with bubbles every 15 years or so. The higher you go, the longer and greater the fall. You can have a high-priced asset or a high-yielding asset, but not both at the same time.

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Buffett says stock picking is too hard for most investors

Warren Buffett explained why he believes most investors should not pick stocks but simply own an S&P 500 index fund. "There's a lot more to picking stocks than figuring out what’s going to be a wonderful industry."

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Latest Updates

Exchange traded products

ETFs are the Marvel of listed galaxies, even with star WAR

Until 2018, LICs and LITs dominated ETFs, much like the Star Wars franchise was the most lucrative in the world until Marvel came along. Now ETFs are double their rivals, just as Marvel conquered Star Wars.

Shares

Four leading tech stocks now look cheap

There are few opportunities to buy tech heavyweights at attractive prices. In Morningstar’s view, four global leaders are trading at decent discounts to their fair values, indicating potential for upside.

Shares

Why copper prices are at all-time highs

Known as Dr Copper for the uncanny way its price anticipates future economic activity, copper has hit all-time highs. What are the forces at play and strategies to benefit from the electric metal’s strength?

Economy

Baby bust: will infertility shape Australia's future?

In 1961, Australian women had 3.5 children on average but by 2018, this figure stood at just 1.7. Falling fertility creates a shift in demographics and the ratio of retirees to working-age people.

SMSF strategies

The Ultimate SMSF EOFY Checklist 2021

The end of FY2021 means rules and regulations to check for members of public super funds and SMSFs. Take advantage of opportunities but also avoid a knock on the door. Here are 25 items to check.

Economy

How long will the bad inflation news last?

The answer to whether the US inflation increase will prove temporary or permanent depends on the rates of growth of the quantity of money. It needs to be brought down to about 0.3% a month, and that's a problem.

Economy

The ‘cosmic’ forces leading the US to Modern Monetary Theory

If the world’s largest economy adopted a true MMT framework, the investment implications would be enormous. Economic growth would be materially greater but inflation and interest rates would also be much higher.

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.