While the global desire for safety continues to fuel demand for Australia’s government bonds, it’s a more uneven story across other domestic credit markets, with corporate loan markets remaining subdued, but promising growth in the domestic corporate bond market.
With the prospect of rising interest rates beginning to weigh heavily on investors, they are moving to shorter duration, and Australia is still attractive, says S&P Dow Jones Indices’ Vice President of Fixed Income Indices James Rieger. “What Australia’s bond markets bring to global investors is high quality fixed income asset classes at shorter duration that have historically provided higher yield than US Treasury and other bond markets.” The country is one of 11 sovereigns holding a AAA credit rating from both S&P and Moody’s.
The Australian Office of Financial Management has indicated expected Treasury bond issuance for 2013-14 will be A$60bn ($54bn). Yields on CGS have increased significantly since May, and an 18 month high of 4.04% was reached on 10-year CGS in late June, following the US Federal Reserve’s comments that it would taper its stimulatory asset purchase programme. “We’re at the low point of the interest rate cycle and starting to head up, so that’s challenging for fixed income investors,” says Susan Buckley, Managing Director of Global Fixed Income at the A$70bn institutional investment manager QIC. “We’re also probably at the low point in the inflation cycle so you can’t overlook that driver as well.” The Australian cash rate is at an all-time low of 2.5%, with inflation at 2.4%.
However, the spread to 10-year US Treasuries has declined to around 100bps, its narrowest level since 2007, “reflecting the reassessment of the economic outlooks in Australia and the US,” according to the Reserve Bank of Australia’s (RBA) August Statement on Monetary Policy.
Shifts in corporate credit funding Corporate issuance has remained relatively subdued since May. Bond issuance by domestic banks has been lower than previous years – around A$17bn in the three months to August – due to low credit growth in the Australian market, and the ability of banks to fund this growth via deposits. Deposits now account for 56% of total bank funding according to the RBA. Almost no long term debt was issued during June due to the volatility in global debt markets.
CEO of the Finance and Treasury Association (FTA), David Michell says given uncertainly about the local and global economic outlook, Australian corporates are generally in funding diversification and refinancing mode, rather than investing in new capacity or seeking business transforming transactions. “The nature of that refinancing is a shift away from bank debt, toward on-market funding, notably lower investment grade domestic corporate bond issues.”
The highlight has been a growing number of BBB-rated domestic issues, Michell says, however, US private debt placements remain the issue of choice for first time diversification away from bank debt.
Syndicated loan approvals picked up in the June quarter but overall loan approvals were down 28% in the second quarter of 2013 from the corresponding period a year ago, according to KPMG analysis. Reasons for this include poor business and consumer confidence, and more positively, borrowers increasingly using the Australian corporate bond market to fund financing.
The FTA’s Michell says Australian investors have demonstrated greater appetite for local corporate debt over the last 12 months and issuers have become more comfortable with perceived risks such as pricing uncertainty from doing deals in what has been considered a thin and illiquid market. “A noticeable response has been a marketing push by banks involved in the syndicated loan market.” In Australia, bank debt has traditionally had a much higher share of corporate funding than in other developed markets.
In the structured issuance markets, RMBS activity has been strong, with just under A$4bn issued since May. Pricing has been steady and spreads have been around their lowest level since the beginning of the financial crisis in 2007, according to the RBA.
Fixed interest in portfolios Overall, fixed interest allocations in Australian institutional investor portfolios have declined over a number of years and remain significantly lower than in many other countries. S&P Dow Jones’ Rieger says more is needed to inform Australian investors generally about the benefits of bond investments. “The bond market is not well known and well utilised by many of the local investors in Australia. There’s a lot of education that has to be done to inform investors about the value of fixed income.”
Additionally, Rieger says, the corporate bond market in Australia is relatively small compared to the corporate bond markets of other developed nations, and this is hampering investor participation.
Allocations to fixed interest may start to increase though, given changes in the structure of the retirement market – in particular, the need for super accounts to provide more stable income as large numbers of the population move into the retirement phase. This structural change, as well as falling term deposit yields, mean institutional investors need to do more with their fixed interest allocations.
“We’re seeing some investors actively moving greater amounts of their exposure from benchmark-driven fixed income portfolios, seeking quite deliberate portfolios that deliver a more consistent return stream, whether that be a more absolute-return approach and less taking on benchmark risk,” QIC’s Buckley says. More diversified credit strategies and lower volatility fixed income strategies are being adopted, according to Buckley – for example, cash plus 2%-type returns, obtained from interest rate, credit, and inflation exposures.
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