Are you sick of chasing the best returns on term deposits? Floating rate bonds whose interest income adjusts quarterly to reflect current expectations of interest rates, may be a solution. Here are three suggested floating rate bonds.
There is a myth about bonds that you would never buy bonds in a low interest rate environment because when interest rates go up, bond prices will fall.
The statement is only partly true. First, bond prices already incorporate future expectations of interest rates. So as I write this note, the market expects interest rates to be cut one more time before they expect them to climb gradually over the next four years. These expectations are already built into bond prices.
Second, there are three different types of bonds that work best in different economic conditions. Fixed rate bonds are most influenced by a change in interest rate expectations.
However there are also floating rate and inflation linked bonds. Floating rate bond prices are much more stable and it’s these bonds that are the focus of today’s column.
Interest on floating rate bonds is like their name suggests and ‘floats’ up and down as it is linked to a benchmark.
The benchmark rate, usually the bank bill swap rate (BBSW) in Australia, will rise and fall over time based on prevailing interest rates. Interest on floating rate bonds includes the BBSW plus a fixed margin that does not change over the life of the bond.
If you think interest rates are going to rise, you would weight a bond portfolio to these bonds as returns will naturally increase in line with expectations of rising interest rates.
Here are three examples you may like to consider, all coincidentally infrastructure assets.
Dalrymple Bay Coal Terminal (DBCT)
Dalrymple Bay Coal Terminal is the largest coal port in Australia and is a monopoly infrastructure asset. It has certain cashflows from the large miners that use the port, no matter what coal they ship, giving bond investors a lot of certainty in terms of interest payments and capital being returned at maturity. DBCT has two floating rate bonds: one due for repayment in June 2016 and the other in June 2021. The short dated bond has an expected yield to maturity of 3.63 per cent per annum and the longer dated one 4.43 per cent, assuming interest rates move according to expectations.
There is just under 1 per cent difference in the two bonds, quite a lot in a low rate environment but also demonstrating the low interest rates expected in the coming years.
Sun Group Finance
Sun Group Finance is a subsidiary of the Transurban-led consortium which manages a network of toll roads in Brisbane. The portfolio comprises four concessions covering the Logan and Gateway Motorways, CLEM7, Go Between Bridge and Legacy Way. The bond was issued to help pay for the portfolio and matures in December 2024 with an expected yield to maturity of 4.69 per cent.
SCT Logistics (SCT)
SCT is Australia’s largest private rail freight operator with a 40 year operating history. They provide a full suite of vertically integrated, national logistics services. The business was established in 1974 as a rail line-haul service and transports fast moving consumer goods including: beer, wine and materials with limited exposure to goods used in mining and no direct exposure to commodities.
This is a high yield bond currently trading with a yield to maturity of 6.44 per cent until June 2019.
