Fixed Interest

As readers of YieldReport will know, many of Australia’s banks have started to promote their cash accounts rather than their term deposits because, from the bank’s point of view, cash accounts are considered to be more ‘sticky’ kinds of deposits as far as Basel III capital adequacy goes.

ANGLO-SWISS miner Glencore has been in the news recently courting Rio Tinto but it made bond market headlines last month for different reasons.

In essence, benchmarks are a standard against which the performance of financial instruments like managed funds can be measured. More often than not, broad market and market-segment indices are used for benchmarking purposes. A benchmark is usually an index of securities from the same, or similar, class: stocks are usually compared against stocks, bonds against bonds and so on.

A cautionary tale for everyday investor folk

Mergers and acquisitions have surged in Australia this year so this is a good time to consider the impact of these events on bondholders.

This month, Glencore, a diversified multinational commodity trading and mining company, issued a bond in the domestic market for the first time. The company has a market capitalisation of around $50 billion and is the nation’s largest coal producer through its Australian subsidiary Glencore Xstrata.

In recent weeks we have written to our clients and to the media about our concerns about the proliferation of “equity hybrids”. Equity hybrids, as opposed to debt hybrids, are hybrid securities that we believe have a risk exposure akin to equities, not bonds due to the ability of banking regulators to force their conversion to equities without any ability of hybrid investors to control this outcome. More concerning is the fact that Australian investors have invested a total of $20 billion in these securities, including the recent $2.5bn CBA hybrid PERLS VII.

The number and scope of fixed income funds in Australia has grown in recent years, reflecting the growing demand from investors for breadth and depth. Some of these fund use strategies that are new to the domestic Australian market and give investors greater scope to diversify their portfolios. From an investor perspective, since some of these funds are newly launched, their strategies may only have short track records. Some of the funds some of the time can assume significant credit risk. Naturally, past performance is not a guide to future performance. As a result of their brief track records, some may have had no experience of managing their way through a rising interest rate environment and tricky credit environments.

The yield curve, also called the term structure of interest rates, shows the relationship between interest rates and term to maturity.

Two recent events brought home how powerless investors in managed funds are when danger looms in the financial markets.

Basel III is having a profound impact on the sort of debt instruments that Australian fixed income investors can access. All capital bonds in a Basel III-compliant environment need to carry a contingent clause that imposes losses on investors under certain conditions.

It is not unusual to come across the phrases ‘steepening yield curve’ and ‘flattening yield curve’ in commentaries discussing interest rate securities. Both phrases refer to the change in shape of the yield curve across different maturities. Interest rate securities come with different maturities and yields generally increase incrementally as maturities extend further into the future. Plotting these yields against each other produces a yield curve such as can be seen below.

In a low yielding investment environment smart investors can still boost their returns by taking on carefully selected risk as part of a diversified portfolio.

In past letters, we have consistently held that the current economic cycle, the resultant investment environment and behaviour of financial markets are unlike anything seen in living memory.

A custodian who invests funds on behalf of others, or for their benefit, is in an extraordinarily trusted position. They are expected to invest wisely and are accountable to a wide group for their actions.

When an investor puts their SMSF into pension phase, they face a new problem they may not have considered which is how to draw down enough money each year to meet the minimum pension payment.

Managed funds can be a useful tool for investors, particularly investors who do not have the time or the skills to undertake a lot of research themselves in choosing individual assets in which to invest.

Key points:

The mFund Settlement Service

Post GFC, there is a renewed awareness of the volatility of markets and the need to diversify investments to hedge against it.

Investors in Australian interest rate securities are likely to come across inflation-linked bonds but may not know what they are or how they differ to non-inflation-linked bonds. As part of its regular programme of issuance, the Australian Office of Financial Management (AOFM) routinely issues inflation linked government bonds. The following article aims to highlight the core things investors should know about inflation-linked bonds.

There’s a misconception in the market that buying bonds means locking away your funds for a long time.

Investors in Australia trying to understand the interest rate securities market will often come across reference to 90 Day Bank Bill Futures. Launched in 1979, the 90 Day Bank Bill was the first interest rate futures contract to be listed outside the US.

In his speech to open the Griffith University Personal Finance and Superannuation school last month, one of Australia’s leading experts on the superannuation system Professor Michael E. Drew continued his decade-long campaign to shift our thinking about how we invest from focusing on promises to looking at reliable outcomes.

Covered bonds are much like normal bonds except that they carry an extra level of security ‘cover’. They are generally backed both by the issuer and by a specific pool of assets. The only issuers of covered bonds Australia are the big four banks plus Suncorp-Metway. Banks have typically issued covered bonds at tenors of 5 to 10 years, compared with a norm of 3 to 5 years for their unsecured bonds.

The Australian interest rate securities market is seeing increasing issuance of Residential Mortgage-Backed Securities (RMBS) from lenders. Because of the attractive ways many of these issues are priced, they are proving to be increasingly popular with investors.

Fixed Versus Floating? It’s All A Matter Of Interest Rate Timing

Australian investors have been blitzed over recent years by newspaper headlines talking about hybrid securities. Many of these hybrids have been issued by high street banks, which can give investors a sense of comfort when it comes to overcoming their concerns about an asset class that can be perceived as risky. Because of this, it can be easy for investors to overlook the risk involved in hybrids in general if they are issued by well-regarded and well-known institutions. Hybrids carry risks that other investment instruments do not.