Powered by MOMENTUM MEDIA

Corporate bonds’ day in the sun

Richard Murphy
— 1 minute read

Australian retail investors have generally been very underweight in high-quality fixed income investments such as corporate bonds. There are various reasons why this might change over the coming year or so, writes Australian Corporate Bond Company CEO Richard Murphy.

Richard Murphy

Australian retail investors have historically had love affairs with a number of asset classes – but not with fixed income securities. According to the Australian Taxation Office (ATO), the total assets under management (AUM) of the country’s self-managed super funds (SMSFs) amounted to $580 billion at the end of March this year, or 10.4 per cent more than at the end of March 2014. Collectively, their largest asset allocations were to listed shares ($164 billion or 28 per cent of the total), cash/term deposits ($157 billion or 27 per cent), managed investments ($106 billion or 18 per cent) and real estate ($82 billion or 14 per cent). Only $5 billion, or less than 1 per cent of the total, was invested by the SMSFs in debt or fixed income securities.

SMSFs and retail investors more broadly have kept very low allocations to fixed income securities even though they have delivered good risk adjusted returns. Over the 22 years to the end of June 2015, the annualised returns from Australian shares, as measured by the ASX-200 Accumulation Index was 9.67 per cent. The annualised returns from Australian corporate bonds – over the same period – were 7.36 per cent. However, volatility of the Australian share market, at 14.98 per cent per annum, was far greater than that of corporate bonds, which was just 2.76 per cent per annum. Relative to shares, the bonds have provided somewhat smaller gains for much fewer sleepless nights. This data makes the obvious case for diversification.

The difference in the volatility highlights another advantage of Australian corporate bonds. They are not correlated, ie. do not perform in line with shares. Bonds have an important role to play in balancing overall portfolios. This is recognised by institutional investors in this country. According to the Australian Centre for Financial Studies (ACFS), Retail and Industry Super Funds held 22 per cent and 14 per cent respectively of AUM in fixed income at the end of June 2013.

High-quality corporate bonds have other strengths. They pay regular coupons and the principal at maturity is known, which means that cash flow planning is easier for the investor than would otherwise be the case. Although corporate bonds can lose value if the risk the issuer might default increases, they are generally less volatile than the securities below them in the issuer’s capital structure, in particular shares, which are at the bottom.

In general, most corporate bonds should offer higher yields than cash, term deposits of the same maturity and government bonds. This is because the credit risk, or the likelihood of default, is higher for corporate bonds. In short, corporate bonds are high-quality investments that may be suitable for risk-averse investors, including those at or near retirement.

All this begs the question: why have retail investors so far not invested in corporate bonds? The main problem has been one of access. Senior bonds from major ASX-listed companies have not been available on the ASX, a marketplace very familiar to many retail investors. The bond issuers (ASX-listed companies) have been able to access funds quickly and cheaply in wholesale bond markets, both in Australia and overseas. In the wholesale markets, the typical trade size is $500,000 or more – which is too much for most retail investors and SMSFs. As retail investors have not been able to readily access high-quality corporate bonds, they have focused on other asset classes that they understand – or, use other investment vehicles to gain fixed interest exposure, such as managed funds or ETFs.

A major change in this normality has been the introduction in mid-May 2015 of Exchange-Traded Bond (XTB) units on the ASX. XTBs individually wrap each corporate bond in an ‘ETF-like’ investment, allowing you to select which corporate bonds to gain exposure to, much in the way you select ASX-listed shares. The big step forward is that XTBs break down the minimum investment size from $500,000 to as little as $100, making it easy for all investors and SMSFs to start including individual corporate bond as part of their portfolio.

During the life cycle of the XTB, it will follow that of the underlying corporate bond. As coupons are paid on the underlying bond, they automatically flow to XTB holders. When the underlying corporate bond matures, the XTB relating to that bond will mature and each XTB holder will receive final coupon and repayment of the bond (face value), just like the underlying bond. Most importantly, you have true transparency in that you can see the bid and offer price of the XTB and the available volume you may trade, like ETFs and shares. This has been the main drawback to the OTC bond market – the inability to view bids, offers, volume and trade history of the market.

The arrival of XTB units on ASX has two major implications. One is that retail investors and SMSFs can effectively invest in corporate bonds on ASX as easily as they can in ASX-listed shares. They have all the advantages of dealing through the ASX, a fully transparent and very well-regulated market. The other is that bond issuers will soon have indirect trading in their bonds via XTBs by a broader range of investors, which among other benefits, may broaden the institutional capacity for that company’s debt.

Given the benefits of corporate bonds, it is possible that demand from retail investors and SMSFs for corporate bonds will grow strongly over time, as the asset class becomes better understood. This, in turn, should encourage more XTBs on other corporate bonds – in effect, producing a virtuous circle of greater supply and greater demand. Fixed income in general – and corporate bonds in particular – could become a mainstream asset class for retail investors and SMSFs.

 

Richard Murphy is the chief executive and co-founder at Australian Corporate Bond Company.

 

 

Corporate bonds’ day in the sun
Richard Murphy
ID logo

related articles

promoted stories

Website Notifications

Get notifications in real-time for staying up to date with content that matters to you.