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Expert Insights

Expert Insights: Everything You Need to Know About the Booming Corporate Bond Market

Set the scene for us: What is happening from a supply and demand perspective in the Aussie corporate bond market. How many issuers have there been this year, what were some surprising names, and who is buying these bonds?

Compared to global corporate bond markets, Australia is just getting started on its corporate bond journey. Historically, the Australian corporate bond market had been viewed as illiquid, small, and only offering shorter-dated maturities. It’s wholesale nature, rather than retail, combined with a competitive bank loan market has also complicated its development.

In our view, this is now changing. We’re seeing Australian corporates issue 10-year deals on a regular basis and in large volumes, partially given the significant oversubscription levels. Utilities and REITs have been the most active sectors in the primary market. The absence of bank issuance (which we expect to continue over the rest of this year) has also helped from a supply perspective.

2021 YTD corporate issuance is now sitting around the AUD16bn mark, over 30% higher than 2020. Improving investor sentiment post COVID-19 has seen overwhelming demand for risk assets amongst investors. For issuers, this tailwind has been helpful in bringing deals to market and extending debt tenors.

In terms of corporate issues, there have been around 40 deals in 2021 YTD. Some of the names to issue were Pacific National, NBN Co Ltd, GPT Wholesale Office Fund, Emeco, Peet. MoneyMe and Wesfarmers (with a sustainability-linked bond (SLB)).

Whilst the retail corporate bond market remains small, the Chair of the Standing Committee Jason Falinksi spoke to twelve recommendations such as lowering the minimum investment to AUD1,000 and streamlining disclosure requirements for corporate bonds.

Watch this space going forward.

The Wesfarmers SLB required the issuer to meet two performance targets:

  • increasing renewable energy sources
  • decreasing carbon emissions.

If performance targets are not met, the coupon will step up by 25bps. ESG corporate issues have found a home in the Australian corporate market and are being warehoused by real money and superfunds.

How can direct investors participate? And what returns can they expect across the credit spectrum?

Direct investors can participate in several ways. IAM’s Direct Fixed Income Investment service provides wholesale investors, advisors, and policymakers access to the Australian corporate bond market in large and small parcel sizes (including AUD50,000). IAM has access to over 150 small parcel bonds available in parcels of AUD50,000. As an IAM investor, you receive a custody account with your fixed income investments in safe keeping.

With IAM’s network and long-standing relationships with debt originators, we have access to unique new issues providing clients more choice, competitive returns, and flexibility when it comes to their defensive investments.

If investors want access to the Australian corporate bond market but don’t have the time or expertise to make these decisions, then an allocation to Fortlake Asset Management may make sense. Fortlake will construct and manage the portfolio, which can be tailored for different risk appetites.

Going forward and mindful of client’s needs we are look at integrating IAM’s systems with certain platforms where our bonds can be accessed from. The advantages of these platforms are that there is no onboarding, and they can handle the settlement/custody process.

In terms of returns across the credit spectrum:

  • A pure investment-grade portfolio will yield an investor a 2-3.5% return
  • A balanced portfolio of 60% investment-grade and 40% high-yield will yield an investor a 3.5-6% return
  • A pure high-yield portfolio will yield an investor a 6-10% return

What is smart money buying? Where is the value in credit/is there better value (and lower profile) opportunities that direct investors may be missing?

As Sydney and Melbourne comes out of lockdown, there are some reopening trades in the Australian corporate bond market which smart money investors should consider as part of their fixed income portfolios.

Smart money investors should consider opportunities coming from bonds in sectors hit hard by lockdowns, that are trading relatively cheap compared to their valuation based on a normalised operating environment. The main sectors include travel, shopping centres, gaming, airports, hotels, and distressed credit players. If these bonds are trading relatively cheap, then there is incremental alpha to be made as the bonds migrate towards their fair value as the Australian economy normalises.

Provided a company’s prospects have not been permanently impaired from COVID-19 (that is, idiosyncratic risk remains quite low for the credit), then we suggest focusing on companies which are high-quality, have good balance sheets, and are industry leaders. These will benefit the most from the reopening as COVID-19 becomes less of a threat. Buying when news is bad — but with light at the end of the tunnel — is a good strategy.

Most of these opportunities lie in the high-yield space as opposed to the investment-grade space. In the investment-grade space, the best opportunities are those credits which have been impacted by ESG-related issues and where pricing has been significantly discounted. For example, coal-related haulage companies are transitioning their business models to more bulk and less coal-related revenues. Over time, we should see a reduction in the ESG discount as companies’ cost of capital declines.

What are some of the lessons we can take away from historic bond failures and how do you recommend investors avoid getting burnt? Are there any recent high-profile failures you can exemplify to illustrate this? Perhaps Evergrande, Virgin, etc. What went wrong?

Some of the lessons to take away from historical bond failures are:

  • Credit ratings almost always don’t reflect default risk
  • Debt structure matters just as much as the probability of default
  • Having a strong balance sheet matters
  • Cyclical credits can be incorrectly priced if based on forward-looking earnings
  • Relying on government support for credit can be futile

Investors can avoid getting burnt by doing proper due diligence and diversifying their portfolios. Due diligence involves looking at the risk prior to the return. Virgin was a prime example, where investors looked at the 9% yield rather than the fact the company had a huge amount of leverage and significant secured creditors.

Furthermore, Virgin had been consistently reporting losses over the past five fiscal years. Many investors get seduced by the yield but when they look purely at the credit fundamentals, it provides a better understanding of the risk/return.

The recent Evergrande situation is also a good lesson for investors, one that has taught them to be careful with property developers who have a lot of uncompleted properties. The debt crisis plaguing Evergrande is just one of many companies at risk in China.

According to Bloomberg, two-thirds of China’s top 30 property developers are struggling under Beijing’s debt rules. In simple terms, liabilities outstrip assets — and many Chinese property developers don’t have good liquidity.

What are some of the current issuances that IAM believes are interesting from a risk/reward perspective? Are there any exciting opportunities coming up in the pipeline?

Capital Alliance Investment Group (CAIG): CAPAAU 10% 21/10/2025

There are several key credit milestones on the horizon for CAIG — starting with the opening of the Marriott in late October, which should coincide with the 80% vaccination threshold in Melbourne. CAIG also has plenty of cash on hand from the Marriott residence sales and residual stock facilities — which will be received by the end of this year. By the start of 2022, there will be three operational hotels that will be ramping up occupancy and cashflows following the completion of AC Hotels (Normanby).

Pioneer Credit: PIOCRE 0 22/03/23 MTN

As the major banks relinquish their COVID-19 goodwill, releasing more purchased debt portfolios (PDPs) to market, Pioneer Credit is well-positioned to acquire those assets at attractive discounts. Concurrently, improving employment conditions for underlying borrowers will drive up recovery values. At this time, Pioneer Credit strikes us as a truly unique proposition, being leveraged to a COVID-19 exit that the market has largely (to date) overlooked.

Crown Resorts: CWNAU 0 23/04/2075

With Sydney coming out of lockdown and Melbourne’s restrictions slowly lifting, there’s an opportunity to buy into the Crown ASX hybrids at a cheap entry point. Despite the regulatory risk that comes with casinos and negative public sentiment on account of The Star’s recent problems, it’s hard not to anticipate that casinos will roar back to life once lockdown restrictions are lifted. Crown is well positioned for a rebound, given its flagship casinos, as well as the fact that The Star (its key competitor) is now facing several issues.

In terms of pipeline:

  • An invoice factoring business
  • Financial services company offering financial solutions and online banking payment solutions
  • Hospitality providers with Victorian and NSW footprints

About Matthew Macreadie

Matthew’s current responsibilities include providing credit commentary/views on the bond market and specific issuers, with the aim of aiding investors to make better risk-return decisions.

Prior to joining Income Asset Management, Matthew spent eight years working as a Credit Portfolio Manager at Aberdeen Standard, where he was responsible for the credit portfolio construction and security selection across a wide range of financial and non-financial sectors.

Matthew began his career at KPMG working in Auditing and Assurance within the consumer and industrials group. Matthew holds a Masters of Applied Finance from Macquarie University and a Bachelor of Commerce from UNSW.

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