Wednesday 30 October 2019 by Jonathan Sheridan Education (basics)

Current top picks – why we think they are good value

The bond market constantly throws up opportunities for investors to maximise the risk/reward equation on investing their capital.  We look at the current top picks and why we think they are good value.

top-bond-picks-october-2019-wire-article

Most equity investors understand they are taking a high risk, with the potential to return multiples of their capital.

Bond investors however usually are looking for single digit returns, and in this lower rate environment, are actually in the low single digits.  This makes the return of capital of utmost importance, and as such risk should be at the forefront of every bond investor’s mind.

Risk therefore is the most important factor to consider when looking at a bond investment.  What then follows is the assessment of whether the return is adequate compensation for the risk being taken.

Using this framework, we have identified our current three top picks in each bond type (fixed rate, floating rate and inflation linked), and provide a brief insight into why we think they offer good value.

Fixed Rate

BondYield 
GEO Group 5.125% 2023 USD1   8.02%

GEO Group Inc (NYSE: GEO) is a US listed real estate investment trust (REIT) with a market cap of approx. $1.9bn.  They specialise in the delivery of diversified correctional, detention, and residential treatment services to government agencies around the globe.

The bond and share price has come under pressure recently for a number of reasons, mainly to do with presidential candidate Elizabeth Warren announcing she would look to abolish private prisons if elected, and some banks, including JP Morgan, announcing they would no longer finance the sector.

Wire Top Picks Chart 30 Oct 2019
This happened before in late 2016 (when we first recommended the bond) prior to Trump being elected, when Hilary Clinton made the same overtures prior to that election.

Our view is that it is not so easy to close these facilities down.  After all, what is to be done with the occupants of them?  They cannot simply be released.  If the prisons were to be nationalised then the operators would receive cash with which they would likely pay back their debt.

We therefore feel that the likelihood of being repaid is high, and at a yield of over 8% this represents good value.

Note these bonds are denominated in USD and so carry foreign exchange risk.

Floating Rate

BondYield 
WorkPac Trust BBSY +5 5.20% 20221   5.34%


Established in 1997, WorkPac is Australia’s largest privately-owned provider of blue and white-collar employees who are contracted out on a temporary, short-term and increasingly permanent basis, primarily to the mining, mining services, civil construction, infrastructure, utilities, and healthcare sectors (within Australia). The Company has around 500 full-time staff servicing 1,500 clients. 

Essentially Workpac pays its workers weekly and receives payment from its clients monthly. It therefore has to fund the timing difference in the cashflow, and that is why it has a facility, secured on the receivables from its clients, to do so.

The notes sit in the second ranking position in this facility behind the bank providing the majority of the funding. Apart from 3 of its largest clients (all of which have strong credit profiles), the remainder of the book is 90% covered for losses under an insurance policy from Allianz.

Essentially this means we are taking risk on 3 of the world’s largest mining companies, and only 10% on any loss from any of the remaining clients.

In our opinion this is a low risk for the return of around 5.3% for just a 2.5 year exposure.

Inflation Linked

BondYield 
Sydney Airport ILB 20302   3.02%

For our preferred inflation linked exposure, it is a case of picking from a very select group. Post the global financial crisis, inflation linked bonds have been declining in availability, as existing ones mature and are not replaced. This is a product of the low inflation environment, and the availability of cheap, simpler credit to the typically very strong investment grade issuers.

As such, the capital indexed bond (this means the capital invested appreciates each year with positive inflation, maturing at a value greater than the 100 issue price) from Sydney Airport maturing in 2030 remains our preferred exposure, despite strong price gains/yield falls in the last 12 months in particular.

Sydney Airport as a business requires little further explanation.  It is a monopoly infrastructure asset with very stable revenues and cashflows – ideal for a bond issuer.

At a real yield (yield over inflation) of 1.52%, and assuming inflation over the next 11 years at a relatively low 1.5%, this equates to a total return of 3.02%.

Comparing this to other similar bonds, such as the Pacific National 2029 at 3.02% (with a credit rating 2 notches lower) and the Dexus 2029 (rated 1 notch higher) at 2.68%, the Sydney Airport bond still looks good value.

We discuss these and many other bonds, how they work and how you can access and build them into a portfolio in our seminars.

Please register here for our Introduction to Corporate Bonds seminars (for less experienced bond investors) and How to build a balanced bond portfolio seminars (for more experienced bond investors).

If you have interest in any of these bonds, or would like to discuss other options, please get in touch with us.

1 Available to wholesale investors only
2 Available to retail and wholesale investors


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