The seemingly never-ending stories of impropriety from the Banking Royal Commission has highlighted inherent risks in being overexposed to this sector, which a large number of investors are. Not only do Financial businesses (banks, insurers etc.) account for over one-third of the ASX200 Equity Index but they also comprise a massive 92% of the listed bond market as investors have been funnelled into bank-issued securities due to a lack of alternatives.
Properly diversifying your investment pool not only means diversification at an asset class level but also diversifying individual exposures at the security level.
Key points for interest-bearing investors:
- Securities issued by major banks represent a massive 84% of the listed bond market
- Most investors are already overweight banks due to equity investments
- The Royal Commission may lead to further regulation and lower returns for bank equity investors
- In an environment of surplus investment capital, businesses continue to prefer issuing in over-the-counter (OTC) bond markets due to ease and reduced regulatory costs
- With listed interest-bearing investment opportunities becoming more limited and concentrated to bank-issued debt, access to OTC bond markets is crucial in managing a properly diversified interest-bearing portfolio
With listed interest-bearing investment opportunities becoming more limited and concentrated to bank-issued debt, access to OTC bond markets is crucial in managing a properly diversified interest-bearing portfolio
The Cameron Harrison Wholesale Bond Facility addresses these issues by providing Wholesale/Sophisticated investors with access to a wider range of securities via the over-the-counter (OTC) bond markets. In reducing the minimum individual parcel size from $500,000 to just $20,000 per security, the facility enables you to invest in a larger number of securities, reducing your exposure to the banking sector and producing a fully diversified interest-bearing portfolio
Diversification Part 1: Listed ASX vs. CH IBS Strategy
With over 84% of issuance in the listed market dominated by the Big 4 Banks (as shown below), the ability for retail investors to diversify and spread their credit risk is limited. The restricted nature of the market leads to higher concentration risk to investors as well as a ‘crowding out’ of investors, further reducing investment choice and lowering yields for those investments that are available.
The alternative for investors is to access the over-the-counter (OTC) market through the Cameron Harrison Wholesale Bond Facility, allowing you to build a portfolio with meaningfully lower exposure to the Big 4 Banks and higher allocations to sectors such as Infrastructure, Healthcare and Real Estate.
Diversification Part 2: Moving up the Capital Structure
Not only does the OTC bond market provide access to more issuers, but it also provides access to more types of securities. The listed bond market is heavily skewed towards hybrid securities which are the lowest in the debt ranking ‘waterfall’ (illustrated below) and therefore the highest risk debt securities. In contrast, the OTC market has a far greater number of higher-ranked debt securities such as senior bonds and asset-backed securities.
This means investors are able to ‘move up’ the capital structure and investor in lower risk debt securities.
Number of securities traded
|TYPE||RISK PROFILE||LISTED BOND MARKET||OTC BOND MARKET|
|Senior Secured Bonds||Low||0||149|
|Senior Unsecured Bonds||Low||5||1,043|
|Subordinated Notes (Tier 2)||Medium||8||49|
|Hybrids (Tier 1) (Preferred Equity)||Medium||43||58|
|Common Equity (Shares)||High||–||–|
Source: Bloomberg (Australian Dollar debt securities settled through Austraclear)
The CH Wholesale IBS Strategy is currently offering investors a sizeable premium to term deposits, with a yield to maturity of 4.9%.
|PORTFOLIO METRIC||VALUE AT JUNE 2018||WHAT IT MEANS…||STRATEGY FOCUS…|
|Running Yield||5.3%||The current income yield on the portfolio.||Generating an appropriate level of income for clients.|
|Yield-to-Maturity||4.9%||The expected return on the portfolio if securities are held to maturity.||Our target is 2.0% above the 3-year government bond rate. The target is currently 4.1%, which we are achieving.|
|Years-to-Maturity||3.6 years||The weighted term-to-maturity of all securities in the portfolio.||At 3.6 years-to-maturity, the portfolio is largely weighted to shorter-dated securities. This is designed to minimise default, interest rate, and credit risks.|
|Fixed/Floating Allocation||15% / 85%||The split between fixed-rate securities, and floating rate securities.||Minimal allocation to fixed-rate securities and a heavier allocation to floating rate securities whose coupon payments increase as interest rates rise.|
|No. of Securities||35||Number of securities in the portfolio.||To construct a properly diversified portfolio to avoid concentration to any one issuer, industry or security type.|
Our portfolio managers have deliberately focused the strategy towards shorter dated (2-5 year), floating rate securities to remove interest rate risk as we enter an environment of rising rates. When interest rates increase, the price of fixed bonds falls, leading to capital losses for investors. Investing in floating rate bonds, whose coupon payments rise as interest rates rise, preserves capital value and purchasing power in a rising interest rate environment. As a result, our portfolio has outperformed the benchmark Ausbond Index over the past 12-months, as interest rate expectations have risen.
Example of a typical corporate bond: QMS Media
QMS media are a leading outdoor media company in Australia and New Zealand, best known for their billboard advertising. Over the past decade, improvements in technology and changes in consumer habits have driven a structural shift away from traditional advertising (TV, print etc.) to new areas, particularly ‘Out-Of-Home’ in which QMS operates.
To capture this emerging opportunity, QMS is convert existing legacy assets (i.e. static) to higher yielding digital mediums. This program is capital intensive, and the company came to the OTC market to raise $70m in the form of senior unsecured notes at a fixed rate of 7.00% per annum.
This corporate bond was added to the strategy as part of the primary offering at a unit price of $100 in November 2017. Since then its value has traded up to $105.79, including accrued interest of $3.29 and capital appreciation of $2.50.
|Product Type||Corporate Bonds||Last Price||$106.62|
|Par Value||$100.00||Capital Price||$102.57|
|PaymeFrequencyncy||Semi Annual||Yield to Maturity||6.36%|
|Current Distribution||7.00%||Trading Margin||3.81%|
|Issue Margin/Coupon||7.00%||Expected Maturity Date||21 Nov 2022|
Diversify, Diversify, Diversify…
Proper diversification not only means diversification across asset classes but also diversification in underlying security holdings. A properly constructed interest-bearing portfolio requires a variety of issuers to reduce concentration risk and securities across the debt ranking spectrum for a balance between income yield and capital preservation.
Cameron Harrison’s partners have been delivering specialist advice to business owners and families for over 50 years. Through our defined planning methodology, our clients gain access to and receive a careful and properly integrated wealth framework.
For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.