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Retail investors and SMSFs move into the bond market

by James Dunn | 01 Sep 2016

Australian self-managed superannuation funds (SMSFs) and retail investors have not been big users of the bond market in the past, but that appears to be changing. 

A combination of influences — both demand and supply — is slowly prising money out of the funds’ traditional favoured asset classes, shares and cash.

On the demand side, retail investors are becoming more aware of the need for diversification in their portfolios, the income flow, stability and certainty that bonds can provide, and how important these qualities can be when planning a self-funded retirement. Many SMSFs and income-conscious investors use high-dividend shares as an income source, but the cut in ANZ Banking Group’s interim dividend earlier this year and the Commonwealth Bank’s flat FY16 dividend have shown these groups that dividend rises are not sacrosanct, and that they can bear significant capital risk in holding shares for yield. So the appeal of other forms of income-generating investments is rising.

In supply terms, retail investors have more avenues to invest in bonds than ever before. Where they were once confined to unlisted bond funds, investors can now choose between fixed income exchange-traded funds (ETFs) and exchange-traded bonds (XTBs) on the Australian Securities Exchange (ASX). The former have enabled investors to gain access to portfolios based on benchmark indices of government, semi-government and corporate bonds from Australia and overseas, while the latter have opened up access to the performance of domestic investment-grade corporate bonds, with the transparency and liquidity of the ASX market. There is now $391 billion worth of bonds listed on the ASX.

The ASX’s mFunds marketplace, launched in 2014, gives electronic access to selected unlisted managed funds through the mFund Settlement Service. It is also an avenue for retail fixed income investment: there are 32 fixed income mFunds that potentially offer exposure to global and domestic corporate bonds. 

Bite-sized bonds

In the past, corporate bonds were only available in $500,000 parcels, making direct ownership of bonds unachievable for many private investors and SMSFs. But vehicles such as bond broker FIIG Securities’ DirectBonds service have opened up access to direct ownership of corporate bonds in smaller parcels, from as little as $10,000 (with a minimum portfolio balance of $50,000).

And crucially, in 2014 the Australian Parliament passed the Corporations Amendment (Simple Corporate Bonds and Other Measures) Act. This amendment aimed to make it easier for both companies seeking finance and retail investors to access the corporate bond market. While the Australian corporate bond market has been aimed mainly at tapping wholesale funding, this amendment was intended to bridge the gap between retail investors and institutional debt markets. 

Under the simple bond regime, the bonds must be “vanilla” senior unsecured debt with no conversions, deferral of interest and no write-off or loss absorption qualities. The scheme allows for a simpler prospectus, making the bonds cheaper to issue and thus increasing the appeal for companies to issue into the retail market.

“The market has been slowly evolving,” says Nick Yaxley, head of research at fixed income advisory firm Bond Adviser. “There have been quite a few impediments — the prohibitive parcel sizes, the prospectus requirements and fact that the credit ratings agencies, in the wake of the GFC, stopped rating issues that were sold to retail investors. 

“It still has some drawbacks. It is difficult to get execution — if you’re a company, let’s say Wesfarmers, you can borrow $1 billion in the wholesale markets in one to two days, whereas even with the streamlined process that has been brought in, going retail would take at least a week. So it is a bit of an impost on the companies,” says Yaxley.

Corporate bonds’ time has come

Nevertheless, he says the corporate bond market’s “time has come” for greater use by investors. “Given the persistently low interest rate environment, term deposits are giving you 2.5 to 3 per cent, and corporate bonds are giving you 5.5 to 6 per cent. The marginal value of money is moving into that area,” Yaxley says. 

Richard Murphy, chief executive officer of the Australian Corporate Bond Company (ACBC) — developer of the XTB vehicle — says the most recent Australian Taxation Office (ATO) data on the asset allocation of Australia’s army of SMSFs shows his firm’s opportunity clearly.

“On the March 2016 quarterly data, SMSFs had 34.4 per cent of their assets ($203 billion) in shares, 14.4 per cent ($85 billion) in managed funds and 26 per cent ($155 billion) in cash and term deposits. In contrast, they had 1.1 per cent ($6.8 billion) in debt securities. 

“That data is not clean — no doubt that a portion of the managed funds allocation is bond funds, and we don’t know if the ATO allows reporting of hybrid securities as ‘debt securities’ or not — so we can’t tell what SMSFs have in corporate bonds at the moment. But moving dollars from the ‘cash and term deposits’ column to the ‘debt securities’ column is obviously what we’re trying to do,” says Murphy.

Murphy says 39 XTBs currently trade on ASX, all senior unsecured bonds, “at the top of the capital queue.” Another 17 issues, 11 fixed-rate and six floating-rate, are in the approval process at ASX. ACBC has introduced four model XTB portfolios, to allow advisers to choose one or a combination of models to suit their clients’ risk tolerance and financial objectives. 

“It’s still early days for us, considering we launched last May,” says Murphy. “We sold $10 million worth of XTBs in 2015, and we’ve just gone through $100 million sold. At the moment we wouldn’t go much outside the S&P/ASX 100 (index), all of our XTBs are investment-grade, but we’re not against sub-investment-grade — we put Qantas on when it was sub-investment-grade (it has since been upgraded). At some point we’ll look to bring on overseas bonds, kangaroo bonds (foreign companies issuing $A-denominated bonds to local investors), but only if they’re very well-known names,” he says.

SMSFs are the big market opportunity for ACBC: they are the natural home for XTBs, says Murphy. “They have massive amounts of money in cash and term deposits, it's not earning enough for them, but they’re sick of the volatility of shares and hybrids. They’re looking for what’s in the middle in terms of risk and return, and it’s corporate bonds,” he says. 

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