Tuesday 10 June 2014 by Elizabeth Moran Opinion

Investors queue for high yield corporate bonds

Early indications are that Australian investors are keen to support the developing domestic corporate bond market; three new high yield bonds were brought to the market last week.

Key points:

  1. Portfolio theory suggests investors should own a range of investments and a small allocation to high yield bonds will boost overall portfolio returns.
  2. US year to date (YTD) high yield issuance to the end of May was a significant USD146.10bn, or 22.3% of all YTD US corporate bond issuance.
  3. The Australian market is developing as evidenced by three new deals last week.

In the bond market, there is a price for everything. No matter the risk, what might seem a poor investment for some is a great opportunity for others.

A good example is Greek government bonds at the height of the European crisis. The yield on the bonds reached a high of 26.2% (bond prices were very low). Hedge funds saw an opportunity and those same bonds now trade at 6.37% and the bond prices have risen, delivering investors handsome returns.

I’m not recommending very high risk bonds but there’s no reason investors shouldn’t consider an allocation to high yield bonds for their portfolio. Higher returns do compensate for higher risks. Portfolio theory suggests investors should own a range of investments and a small allocation to high yield bonds will boost overall portfolio returns. High yield bonds are issued by companies that are rated “sub investment grade” but in reality can prove to be “gold” for canny investors. High yield Australian corporate bonds yield from around 6.5% to over 9% per annum.

While the Australian high yield market is in its infancy, the US high yield market is well-developed. The Securities Industry and Financial Markets Association (SIFMA) estimates the US high yield bond market to be worth USD1 trillion. YTD issuance to the end of May is a significant USD146.10bn, or 22.3% of all YTD US corporate bond issuance. Many Australian companies issue into this market (Fortescue, Nufarm, Bluescope) as an Australian high yield market hasn’t existed until Qantas was downgraded by the credit rating agencies earlier this year.

When Qantas first issued its 2020 bond the company was investment grade but has since been downgraded (known as a “fallen angel” in the US). After the historic launch and successful issue of its 2022 fixed rate sub investment grade bond the company issued a third bond last week, maturing in 2021 at a fixed rate of 7.5%, with similar characteristics to the 2022 bond. The 2021 issue raised another $400m for Qantas, taking total domestic issuance to $950m.

Other high yield options include bonds that are not rated. Over the last week two small, non-rated deals have come to the market.

ASX listed, NEXTDC launched a five year fixed rate bond . NEXTDC is a Data-Centre-as-a-Service provider offering IT services such as cross connects, rack space, ID access cards and remote hands through five data centres throughout Australia.

The target for the issue was $30m but significant demand meant the issue size was doubled to $60m the next day. The bonds will pay interest of 8% per annum but will also accrue a further 1% per annum, payable upon maturity. The bonds are a senior unsecured obligation of the issuer but rank behind secured lender, NAB.

Last Wednesday FIIG Securities launched its ninth high yield deal, this time on behalf of Plenary Group. The $35m, seven year bond will pay a 7.5% coupon and provides exposure to eight Australian public-private partnership projects. Plenary will start to repay principal after year four. The projects include the Melbourne Convention Centre, Gold Coast Light Rail and the Victorian Comprehensive Cancer Centre.

Key in any bond assessment is whether you think the company will “survive”. If you think the company will still be operating when its bonds are due to mature, then you can expect to be paid your interest and returned the face value of the bond. High yield bonds play an important role in financing companies worldwide. Early indications are that Australian investors are keen to support the developing domestic market.

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