An annuity portfolio

The portfolio

We have put together a portfolio of high quality IABs all linked to social infrastructure with government backed revenue streams. The portfolio is based on five issues spread equally on a face value basis – however due to the varying pay down rates of the bonds the individual purchase price of the bonds vary.

The total cost of the portfolio for your clients would be $235,717, which would return a yield to maturity of 5.97%; a strong return for a portfolio with an average credit rating of ‘A’. Over the life of the portfolio your clients would receive $398,437 in return for their initial investment of $235,717. All of the bonds are ranked Senior Secured, giving your clients security over the project asset (which is the government cash flow stream).

The portfolio has a final maturity (from the NSW Schools IAB) of November 2035, however includes some of the shorter dated IAB maturities in Praeco (2020) and County Courts of Victoria (2022) which helps drive a higher income for your clients over the first half of the portfolio life. We would generally consider this ‘front loading’ of income for portfolios as investors tend to become less active as time goes on and as such require less income to fund their lifestyle.

This is intended to act only as a sample portfolio, the size, and structure of the portfolio can easily be tweaked to better suit your clients specific circumstances and investment power.

The issuers

Due to their amortizing nature, IABs are best suited to issuers that have a finite deadline and all of the issues included in our portfolio have just that. In Australia the public-private partnership market, and in particular PPPs associated with social infrastructure have issued IABs. These projects are characterised by their long term government backed cash flow stream which stretches out over a defined contract period. In return for this government revenue steam the issuer usually has to deliver the social infrastructure to a useable level. Importantly, these projects are considered ‘availability contracts’. That is, the consortium running the project only needs to ensure the building is there, available and fit for purpose. The consortium does not bear any ‘volume’ risk. For example, with NSW Schools, the consortium only needs to build and maintain the school to receive their payments, they have no risk as to whether there are enough students to fill the school, this risk remains with the government.

All of these projects have completed construction and are now in the low risk operational phase. Generally this phase includes building and grounds maintenance, but can also include car parking, security, help desk and other ancillary services. None of the projects are required to provide operational services, again in the example of the NSW Schools issue, this would be the provision of teaching services. The projects contract out the provision of these services to specialist providers (for example Spotless Cleaning for cleaning and maintenance services and Wilson Parking for parking services) with the cash flows designed to cover the contracted cost of the provision of these services.

Below is a brief description of the individual projects:

• Praeco – is the consortium which built and now maintains the Department of Defence Joint Operations Command Headquarters just outside of Canberra. Its revenue stream comes from the Commonwealth Government.
• JEM CCV – is the consortium associated with the County Court of Victoria and as such its revenue comes from the Victorian Government.
• Civic Nexus Finance – runs the Southern Cross Station assets in Melbourne Victoria, the ground transport gateway for the state capital. The revenue stream comes from the Victorian Government.
• JEM Southbank – built and maintains the Southbank TAFE facilities in Brisbane, Queensland. Its revenue stream is guaranteed by the Queensland Government.
• JEM NSW Schools II – this consortium built and maintains 11 schools in NSW and receives its revenues from the State of NSW.

It is worth noting that whilst three of these issuers include “JEM” in their name, they are all independent of each other and have no financial or legal association.

The returns

As we have noted above, the yield to maturity achieved on this ‘A’ rated portfolio is a healthy 5.97%, but what do the actual cash flows look like?

The graph below shows the quarterly cash flows which would be generated by our sample IAB portfolio. As you can see the chart shows an upward slop across the quarterly payments, this reflects the inflation indexing of the bond interest payments as you would expect with an Inflation-indexed annuity bonds. The drop in the cash flow streams reflects the maturity of the individual bonds after which they obviously no longer contribute to the cash flows.

Figure 2

​​A detailed breakdown of the quarterly cash flow amounts is available however, over the life of the portfolio your clients would receive $398,437 in return for their initial investment of $235,911.

This translates to an income of circa $20,000-$25,000 through to 2021 when the maturing Praeco and JEM CCV issues sees income decrease to around $13,000-$16,000 for the period through to 2032 when Civic Nexus matures with a lower level of income in the final years through to 2035.


Figure 3

As noted above, there is obviously scope to scale the portfolio to meet your clients’ specific needs or to front load or skew towards the longer maturities depending on age and income requirements.

Conclusion

For investors looking to provide an income for themselves in retirement, annuities can tick a lot of boxes and with a well designed portfolio of Inflation-indexed Annuity Bonds your clients can get the benefits of an annuity cash flow stream from highly rated issuers whilst still earning strong returns.

Note: Prices are at 1 March 2013. Yields and returns are based on a CPI inflation assumption of 2.5% over the period of the bonds which represents the mid-point of the RBA target inflation band of 2% to 3%. This report and the yields and prices of the securities are provided by FIIG based upon available yields and prices sourced from leading market makers and data services as well as any available market information and feedback when market volume and turnover is low or not transparent as at the reporting date.

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