'Better Fixed Income Portfolios: Innovation Meets Need,' Richard Murphy, Co-Founder and Chief Executive Officer, Australian Corporate Bond Company

Innovation and technology are supporting better fixed income portfolios by making it easier for retail investors to access corporate bond returns on the ASX.

Global volatility is causing investors around the world, including Australia, to think a lot more about capital security, yield and outcome-focused investing. Originally spurred by the GFC, volatility has emerged as the new norm, with Brexit and local election uncertainty the latest examples of the unpredictable world we live in.

In this context, the search for capital stability has intensified. Investors are looking for safety and security in a world of ups and downs. This means the role of fixed income has never been more important.

Fixed income assets are defensive and play an important role in generating regular income with strong capital preservation. Fixed income plays an anchoring role in diversified portfolios because it is not correlated with equities and hybrids.

Incorporating corporate bonds into portfolios is a good way to safeguard investors’ portfolios and defend against equity downturns. But up until now, corporate bonds from ASX top 100 companies have been difficult to access as they’re not listed on ASX alongside shares. Hybrids are listed but they don’t have the capital stability of bonds because of their equity features.

 

An absent asset class

Self-managed super funds and individual investors have had very low allocations to fixed income securities. This is despite the good risk adjusted returns they’ve delivered. At the end of March 2016, Australia’s 572,424 SMSFs held 29 per cent of their assets in listed stocks, 26 per cent in cash and term deposits and 17 per cent  in Australian real estate. While cash in the bank is fixed income, investments in fixed income securities that you can buy and sell amounted to just over 1 per cent of SMSFs’ assets.

Lack of awareness, information and most importantly, opportunity are the reasons Australian investors have been so underweight in high-quality fixed income investments, such as corporate bonds. However, this is changing.

 

Innovation to address the asset imbalance

A number of developments and innovations are paving the way for investors to build better fixed income portfolios. In 2012, ASX introduced exchange-traded Australian Government Bonds (AGBs). They’re traded on ASX and can be bought in $100 units. This was closely followed by fixed income exchange-traded funds (ETFs), which track an index.

Two key developments over the last year include the arrival of XTBs (Exchange Traded Bond units) and the rising popularity of separately managed accounts (SMAs).

In 2015, the introduction of XTBs over individual corporate bonds from ASX top 100 companies opened up corporate bond returns to all investors. Previously this market was the domain of institutional investors.

Unlike ETFs, a single bond backs each XTB. XTBs may be accessed on ASX in $100 lots. This enables investors to build diversified portfolios of corporate bond exposures. XTBs mature like their underlying bonds, so investors get their money back, unlike ETFs and managed funds, which are perpetual. This means you know on the day you invest what returns you are going to get and when you’ll get them, subject only to the corporate issuer not defaulting.

XTBs turn corporate bonds into a form that fits the exchange and platform technology of the wealth management industry. Direct bonds in the over-the-counter (OTC) market are difficult to access and can’t be held on wrap platforms, or in CHESS. This is because OTC securities do not generally meet the STP technology needs of platforms. XTBs do meet those needs, which opens up fixed income for investors across the country.

Recognised as one of “eight smart ideas transforming financial services” by the AFR and Best Disruptor at the 2016 Afiniation Melbourne Showcase, XTBs provide an easy way for investors to get corporate bond returns.

SMAs are also assisting retail investors to access better fixed income. SMAs have similarities with managed funds, in that SMAs have a range of securities, but unlike funds, you own the individual securities outright.

Previously, bond SMAs have not worked well because SMAs sit on platforms that require price and volume data feeds to work efficiently. The OTC bond market generally has great difficulty providing this data. Together though, XTBs and SMAs mean that investors, often with support from financial advisers, can invest directly into tailored portfolios of individual fixed income securities.

In a low interest rate, volatile world, fixed income is arguably more important than ever. We are proud to be a part of the product innovation paving the way for better, and more, fixed income opportunities for individual investors.


 

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