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Marcus Christoe

Can an expanded fixed-income allocation solve the hunt for yield?

By Marcus Christoe
6 minute read

Australian investors face a dual challenge this year: seeking returns in a low-rate environment, and protecting their portfolios from the ongoing volatility associated with COVID-19.

The typical portfolio construction in Australia of property, equities and cash, has left investors woefully unprepared for this challenge. Term deposit rates are now lower than the inflation rate, and the Reserve Bank of Australia has made it clear its focus on unemployment means the cash rate won’t rise from its current level of just 0.1 per cent for at least three years.

At Citi, our high-net-worth clients have flocked into fixed income this year as one way to achieve yield while still opting for a more defensive asset class that can withstand market shocks. Citi’s bond transaction volume in January-February 2020 increased by 90 per cent compared to the same period in 2019. Additionally, in September, Citi hit an all-time record for the number of fixed-income transactions, and fixed-income assets under management increased approximately 32 per cent from September 2019.

These investments were typically in high-quality investment-grade bonds – the most popular type of bond for those Australians who do include fixed income in their portfolio. Issued by a company, these bonds have been given a minimum rating by one or more of the three international credit ratings agencies of BBB- (or equivalent). Investment-grade bonds range between AAA to BBB-.


Names you would expect to see in investment-grade bonds may include the likes of Amazon, Telstra, Westpac, Coca-Cola, ANZ, Vodafone, Citibank and BNP Paribas.

It’s important to call out the difference between corporate and government bonds, as the latter currently provide little or no real return. Following the latest rate cut, yields on Australian government bonds out to five years reached historic lows, according to Reuters. For instance, the yield on three-year government bonds dipped to 0.11 per cent.

However, corporate bonds can still offer “in-the-money” returns. We currently see returns of between 2 per cent to 3 per cent a year across vanilla investment-grade bonds for our wholesale client base. This return is one factor driving the popularity of fixed income. There are a number of other reasons, including that corporate bonds can remain resilient in times of market stress and work as an uncorrelated asset class that hedges against equity market downturns. Hybrids, high-yield bonds and capital notes can offer real value, as they sit somewhere in between equities and traditional bonds on the risk curve.

For self-funded retirees who rely on a regular income stream from their investments to support their retirement, this remains a far cry from the type of returns they have grown accustomed to. 

Investors who are willing and financially able to go up the risk curve can access other types of fixed income like high-yield, hybrids or capital notes that have the potential for greater appreciation if the issuing company performs well. At the same time, there is a greater potential for loss if the company does not perform well. 

Put simply, a high-yield bond is a corporate bond rated below investment grade. But that does not mean it can’t be a good investment. High-yield bonds are from corporates that have been given a lower rating by the credit agencies – Moody’s, S&P Global and Fitch Group. The rating evolves around the agencies’ analysis on the likelihood a company will default on its debt payments.

High-yield bonds fall between BB+ to D. Citi only offers high-yield bonds with a rating between BB+ to BB-, and all offerings are researched by our global team and hand-picked. We offer access to approximately 2,200 bonds, with our nearest competitors offering around 650.

The types of names that fall within the high-yield category include Uber, Mattel, Virgin, Tupperware and SoftBank Group.

As the chart shows, high-yield bonds can achieve equity-like returns in the right market conditions, with less impact from market volatility.


Source: Bloomberg as of October 2020

In its 2018 global bond default report, international ratings agency S&P Global, noted there were 82 defaults in the year, all in the high-yield category, but nearly three-quarters of those were towards the bottom end of the ratings scale at CCC or below.

In addition, 50 per cent of the defaults came from the consumer services and energy sectors, which have been undergoing structural change for a number of years, so you can further manage risk by examining lower default industries like insurance, utilities, financial institutions, health and telecoms.

Another option in the income space is hybrids. Hybrids can be listed on the Australian Stock Exchange, as are some bonds, or picked up directly from the issuer. Like bonds they are a debt instrument issued by corporates, typically banks.

For the investor the attraction is an income return from regular interest payments. However, hybrids have some unique characteristics that can vary from issue to issue, and require a higher understanding from the investor on the terms involved, compared to some more vanilla-type investments like an investment-grade bond.

Access to hybrids is a problem for Australian investors to date, with our limited local market often centred on the financial sectors. For investors looking for diverse options, the global over-the-counter market is a much larger and more liquid market than the ASX-listed hybrids offering. The hybrids offered by Citi are over-the-counter hybrids available via the global market. This expands investor access beyond Australia’s ASX-listed hybrid market of $40 billion to the global US$181 billion hybrid market.

Generally, hybrids have a long maturity date, often in decades, but have options where the issuer can call in and pay out the instrument – and that is typically what the investor expects will happen. However, if things go awry and the issuer gets in trouble there are a number of things that could occur. This could include, but is not limited to, interest payments being deferred, potentially for years, or conversion into equity in a company that may not be financially viable, making them near or possibly worthless.

Hybrids are a more sophisticated investment, require a solid understanding of the risks involved, but can potentially be a good performer for the income side of a portfolio.

The hunt is still on, but fixed income is part of the solution

In other countries like the US or Japan, where rates have hit zero or gone negative, they have stayed at low levels for long periods of time. This means our yield “hunt” is here to stay. More and more income-seeking investors are moving up the risk curve and considering other asset classes that are still producing an acceptable return.

This does not have to be cause for panic, as good portfolio management and awareness of the investment options available can still create a relatively low-risk portfolio producing acceptable returns. Diversification and an understanding of risk appetite remain key for investors looking to strike the right balance in a portfolio that is both defensive and income generating.

Marcus Christoe, head of product for wealth management, Citi

Any advice is general advice only that does not consider your individual situation.

Can an expanded fixed-income allocation solve the hunt for yield?

Australian investors face a dual challenge this year: seeking returns in a low-rate environment, and protecting their portfolios from the ongoing volatility associated with COVID-19.

Marcus Christoe
Marcus Christoe
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