Explainer: Why fixed income brokers want to get you into bondage

Bonds, not the type featured in that episode of Billions but the kind that sit in an investment portfolio, have rapidly entered the retail investor consciousness — but for all the wrong reasons.

Headlines like Italian mafia bonds sold to global investors, Bondholders try to torpedo Virgin Australia sale and Bond investors see trouble ahead would suggest bonds aren’t the financial safe havens their proponents suggest — particularly after the nervousness among bondholders before and during the March market rout.

At the same time, bond advocates point to the lack of returns from blue chip equities over the last decade.

For example, the value of CBA (ASX:CBA) shares grew by 4 per cent a year in the last decade, or shrank by 1.5 per cent a year if measured over the last five years.

Advocates say a bond with a 5 per cent interest rate offers a better, steady return for a fraction of the risk.

They also say the Virgin collapse is turning out exactly the way it should for bondholders, with equity owners walking away with nothing and bond investors, as unsecured creditors, receiving cents in the dollar for their loans.

With corporate and government bond issuances surging, bond brokers and experts are again trying to educate the Australian public on why fixed interest investments belong in a portfolio.

 

Bond ETFs

Bonds, as explained by Chris Rands at Nikko Asset Management, are at their simplest a loan on which interest (a “coupon”) is paid every year.

If the interest rate you agreed at the start of the term is higher than prevailing rates offered by the market, you’re making a bit more money than the going rate and you’ll be able to sell your bond for a premium.

If your coupon falls below that offered by the market, you’re losing money and will only be able to sell at a discount.

Bonds usually have a high minimum buy in — often $500,000 for over-the-counter trades, but managers such as FIIG Securities have a $250,000 minimum.

The Virgin bond offer in late 2019 enticed retail investors with parcel sizes of $5000, a rarity in Australia where tax laws can discourage local issuance and where the market is so immature compared with other foreign jurisdictions that retail investors rarely get a look in.

However, there are a growing number of ETFs listed on the ASX which provide retail investors the return, without the hefty ante.

There are 21 Australian dollar bond ETFs listed on the ASX and 11 global bond ETFs, which are a mixture of government, semi-government and corporate bonds.

 

Not so attractive

With interest rates at record lows and investors looking for an equity recovery similar to that seen after the 2008 crash, bond advocates have their work cut out.

Paul O’Connor, the head of Janus Henderson’s multi-asset team, says investors face the difficult choice between expensive and crowded assets, such as bonds, or cheap and volatile ones such as growth equities.

“The unifying characteristics of this group are that they are typically very sensitive to interest rates and usually perform well in an environment of slowing growth and inflation,” he said.

“While coronavirus concerns persist, we still see an important role for these assets in multi-asset portfolios. However, our enthusiasm is somewhat tempered by the fact that the risk-return outlook is less attractive than it was a few months ago, after a period of strong performance.”

Bond offerings from Australia-domiciled issuers raised $US72.2bn in the first half of 2020, a figure that’s up 44 per cent on the same period last year and the highest first half period since 2017, according to Refinitiv.

Australian governments and agencies made up just over half of that, as the Australian Office of Financial Management issued a record $31.9bn in April and May as the central bank’s COVID-19 economic shot in the arm.

The financial sector accounted for 40 per cent of the total.

However, at the same time equities have been hot property: while professional investors have been talking down markets since April, retail investors have been buying in, and everyone has been dumping fixed interest ETFs.

Betashares’ half year review found that 2020 so far has been a complete reversal of 2019, fixed income received the highest level of inflows of all ETF categories.

“Australian broad equity products have been dominant in 2020, receiving more than 1.5 times the flows of the next biggest category, global equities, receiving inflows of $3.5b and $2.1b respectively,” the report said.

“In contrast, only $263m flowed into Fixed Income over the half year, with investors appearing to reduce allocations to bonds as yields continued to fall.”

 

But companies need the cash

But there are opportunities to be had in bonds this year.

FIIG chief investment strategist Jon Sheridan says companies are looking to shore up their cash positions ahead of the withdrawal of government support.

“Companies need cash now to bolster their cash position now because they know they’re going to need it to get through the next year or two,” he told Stockhead.

But the extra risk posed by the current economic conditions means that companies which he still considers to be backed by strong fundamentals are raising debt at higher rates.

“Examples of challenged businesses due to COVID-19 would be Qantas (ASX:QAN), they raised some money secured against their aircraft for example. Brisbane Airport just did a 10 year bond deal at margins much much wider than they were trading at prior.”

Brisbane Airport bonds were trading at 200 basis points over the equivalent government bond before the pandemic, and its new 10 year bond had a spread of 370 basis points.

“For the same credit, the additional risk from COVID-19 has nearly doubled the spread,” Sheridan said.

“But then Brisbane Airport couldn’t be more affected by COVID-19. We think they’ll be fine over time, but the market is pricing the risk higher.”

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