by
Elizabeth Moran | Mar 03, 2015
This article was published in the Australian on Saturday. Australian government bond yields exceed, by far those of other AAA rated countries.
Australia is a privileged member of an elite club. It is one of only nine countries that have the highest AAA or equivalent credit rating from all three major credit rating agencies.
The credit rating relates to the perceived risk of investing in Australian Commonwealth Government Bonds. The higher the rating, the better. Having the highest rating with few other countries at this level, means global investors are attracted to investing in our Federal Government bonds.
Importantly, it means that for Australia, the cost of borrowing is low. Downgrades to the rating would imply higher risk and mean it would cost more to borrow. So, achieving the highest rating and maintaining it is an important economic goal.
Domestic interest rates, while low are relatively high on a global scale. Of the nine AAA rated countries, Australia still offers the highest returns for two year government bonds at 1.87 per cent, while four countries: Switerland, Denmark, Germany and Sweden show negative returns on their two year bonds. Switzerland has the lowest rate at -0.82 per cent, making it profitable for the government to borrow money!
Australia is often compared to Canada yet Canadian two year bonds only return 0.47 per cent, while the closest AAA offering of 1.01 per cent, from Singapore, is still almost half the Australian rate. So, on a relative value basis Australian Commonwealth government bonds offer outstanding value.
Investors still buy bonds with negative returns as they are very defensive assets that will ensure capital is protected in the event of another GFC type event. In fact, a severe event would see investors sell higher risk assets and invest in these bonds, pushing the price of the bonds higher. It would probably deliver a higher than expected gain on the bonds (over and above interest income) and cushion the impact of the event on the total portfolio.
For sophisticated investors that can access corporate credit ratings, they help qualify the riskiness of an investment. Reassuringly, the vast majority (by value) of Australian corporate bonds are assigned credit ratings and I would estimate that more than 98 per cent are investment grade. According to credit rating agency, Standard and Poor’s, the chance of an investment grade issuer not paying interest or principal is just 1.07 per cent over a five year term.
As the credit ratings decline from AAA down the scale, to AA, A, BBB, BB and so on, the investment is perceived as higher risk and so investors demand higher returns to invest. For example, three corporate bonds all fixed rate and maturing in 2020, but in various credit rating brackets show a range of returns.
Stockland, the highest rated bond in the sample has a low yield to maturity of 3.60 per cent. Moving down the scale, Lend Lease is higher risk than the Stockland bond but is still rated investment grade, that is higher than BBB-, and pays a higher return of 3.95 per cent to maturity. Qantas has a sub-investment grade bond and will return 5.00 per cent if held to maturity. These bonds show that as credit ratings decline, perceived risk increases, so do returns on offer.
Risk increases markedly once investments drop below investment grade BBB, with the chance of a sub-investment grade issuer not paying interest or principal 16.03 per cent over the same five year term. It is at the fringes of just above or below the investment grade cut-off where good credit analysts and astute investors can maximise returns when investing in bonds.
Copyright The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
Disclaimer Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.
No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.
FIIG Securities Limited (‘FIIG’) provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. FIIG’s AFS Licence does not authorise it to give personal advice. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. FIIG, its staff and related parties earn fees and revenue from dealing in the securities as principal or otherwise and may have an interest in any securities mentioned in this document. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.
An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.