Summary: In the wholesale corporate bond market, the minimum transaction size is $500,000 at a time. But new exchange traded bonds allow investors to buy a small parcel of a bond over the ASX. Exchange traded bonds are lower yielding than other products available on the ASX, but offer lower risk.
Key take-out: Exchange traded bonds allow retail investors a degree of access to the wholesale corporate bond market, but the fees charged reduce the yields on offer, while investors are exposed to the credit risk of both the bond issuer and the trust.
Key beneficiaries: General investors. Category: Investment bonds.
Nirvana for retail corporate bond investors might be having direct access to the corporate bonds traded in the wholesale corporate bond market, given the paucity of alternatives available. But this market is only open to sophisticated and institutional investors, and even for the former, access can be a challenge with the minimum transaction size being $500,000 at a time.
Some retail corporate bond investors choose to deal through specialised fixed income brokers who will break down $500,000 parcels of bonds into smaller $10,000 lots. But this has drawbacks with a lack of visibility around the true price being paid for the bond, which could be some way from the price being achieved in the wholesale market, and liquidity, should an investor wish to sell the bonds before maturity.
The ASX has been working to overcome these problems for retail investors by taking bonds from the wholesale market and listing them on the ASX, just as it has done for Commonwealth government bonds. However, this process of transmutation requires enabling legislation to be passed by federal parliament, and unfortunately, the enabling legislation remains well down on the legislative agenda of the current government.
In other words, don’t hold your breath waiting. The outcome is likely to be fatal.
However, some corporate bonds have made it onto the ASX in a slightly different form, but one that does offer transparency and liquidity.
Last month, the Australian Corporate Bond Trust listed 17 separate classes of units on the ASX. Each class of units represents an underlying corporate bond from the wholesale market.
The underlying bonds offered are senior ranking, unsecured bonds issued by Australian listed companies, more than one year ago. Thus, investors benefit from being able to buy senior ranking bonds, which are as rare as hens’ teeth among the other debt securities listed on the ASX, from the continuous disclosure requirement imposed on those companies, and from the seasoning of the bonds in the wholesale market.
The classes of units offered cover bonds issued by Aurizon Holdings, BHP Billiton, Crown Resorts, Dexus Property Group, General Property Trust, Incitec Pivot, Lend Lease, Mirvac Group, Novion Property Group, Scentre Group, Stockland Trust, Telstra, Wesfarmers and Woolworths. The units will provide investors with a great opportunity to diversify their bond portfolios.
Referred to as exchange traded bonds (XTBs), each class of units offered by the trust effectively function in the same way as an exchange-traded fund. The trust has bought the underlying bonds in the wholesale market and then sold XTBs, against the underlying bonds, to the market maker who will make bid and offer prices for trading the XTBs on the ASX.
The market maker for the current batch of XTBs is Deutsche Bank, with prices currently being made on 12 of the 17 XTBs. Prices are expected to be available on the remainder shortly.
The process for setting the initial price of the XTBs is transparent and efficient. It is simply the unitised cost of acquiring the underlying bonds from the wholesale market less a one-off, upfront charge of 0.40 per cent per annum on the face value of the bonds, to cover the operating costs of the trust.
This means that buyers of XTBs will initially pay more to acquire the XTBs but will receive subsequent coupons paid on the underlying bonds, passed through in full, with no ongoing charges deducted.
Secondary trading on the ASX is facilitated by the market makers (others are expected to join Deutsche Bank over time, as additional classes of units are introduced) standing ready with bid and offer prices for the bonds. Current prices can be found on the ASX, searching under equities and using the full six letter ticker code assigned to the XTBs. All codes start with YTM and then use the three letter code of the issuer concerned. For example, the ticker code for the Aurizon bonds is YTMAZJ.
Brokers such as Bell Potter and Morgans include the XTBs on their daily rate sheets, and the net asset value of the XTBs is advised daily to the ASX.
This sounds pretty close to nirvana, doesn’t it? Well as always, it’s not quite there.
The significance of upfront charge levied on the XTBs shows up in the yields that investors can expect to earn. For the XTBs currently offered the charge has the effect of reducing the yields achieved by investors by 0.385 per cent to 0.423 per cent from the wholesale market yield.
When the yields on offer in the wholesale market range around 2.9 per cent to 4.2 per cent per annum – for XTB holders these charges reduce those yields to 2.5 per cent to 3.7 per cent. In a low rate environment this is quite a reduction.
Another consideration is that not only are investors exposed to the credit risk of the bond issuer, they are also exposed to the credit risk of the trust, and should the trust become insolvent they could lose all or some of their investment.
While this risk may be remote, the wholesale corporate bond market experiences periods of illiquidity, especially at times of high risk aversion, say when Greece is threatening to default, and this could adversely impact the ability of market makers to do their job. In these situations bid-ask spreads will be wider than they otherwise would have been or there may be no bid at all.
The challenge for the XTBs will be to divert the attention of retail investors away from the higher yielding, higher risk product currently available on the ASX. The XTBs are lower yielding but also offer lower risk.
The XTBs come much closer to offering the true diversification benefits of bonds in a multi-asset investment portfolio.
Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.