This article appeared in the July 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
The new ASX Exchange-traded Australian Government Bond market opens great opportunities.
By Darryl Gobbett, Prescott Securities
The ASX's introduction of a traded market in Australian Government Bonds (AGBs) opens up significant new opportunities for retail investors and their brokers and advisers.
This is in regard to the specific securities on offer, the broader classes of fixed and variable interest debt that could be listed as investors and advisers gain experience with Exchange-traded AGBs, and the increased capacity to create high-quality government-guaranteed income streams and annuity-type structures.
This was why I thought it was important that my superannuation portfolio and Prescott Securities was involved in the first AGB transactions, specifically in buying the GSBK14 (Exchange-traded Treasury Bond).
I also wanted to be involved in another bit of AGB history, as I was part of the group in Federal Treasury arranging the introduction in 1982 of the bond tender system to replace the Tap system. I was also Treasury representative at the Reserve Bank for the collation of the bids for the first tender on August 5, 1982.
For the record, the coupons on each of the three stocks offered - April 1984, April 1986 and April 1988 - was 16 per cent. The weighted average yield on bonds allotted was 16.45 per cent, 16.64 per cent and 16.51 per cent. A total of $350 million was allotted across the three stocks.
Why Australia had lagged other countries in fixed interest markets
The comment often made about investment and superannuation portfolios in Australia is the limited allocation to fixed-interest securities such as government bonds, in contrast to the US, Europe and Japan.
In the US a retail investor's portfolio may often have 40-50 per cent allocated to a mix of municipal, state and federal government bonds, along with company bonds and certificates of deposits (CDs) issued by banks. The CDs are the equivalent of our banks' term deposits and may be tradeable.
The volume of such securities issued to retail investors and traded would often be much greater than the turnover in equities.
In Australia, the comparable types of debt securities have generally only been issued to large institutions. Retail investors could sometimes buy state and Commonwealth securities directly in small parcels from the respective government treasuries and the Reserve Bank, but there has been no comparable listed public market in these securities, as there is for Australian shares.
This, in my view, is not because of a lack of appetite from retail investors for fixed-interest securities. It has been more about the debt management focus of federal and state governments since the 1980s.
For example, until 1986 the Federal Government had issued bonds that were specifically for retail investors - initially "special bonds". From January 1976 they were superseded by Australian Savings Bonds; 29 ASB series were issued, the last in November 1985, with maturities generally of seven to eight years.
At their peak in February 1984, ASBs on issue totalled $7.53 billion. Not all were held by retail investors but most probably were. In context, the value of these holdings was equivalent to 22 per cent of total deposits at savings banks, or 46 per cent of fixed-interest deposits of trading banks held by the public.
The $7.53 billion of ASBs outstanding was equivalent to 12 per cent of the then $64.8-billion market capitalisation of the Sydney Stock Exchange.
Although ASBs were not listed, they were transferable and there was an active equivalent of an over-the-counter market via stockbrokers.
At the same time, retail investors were major holders in the mid-1980s of corporate debentures and the securities offered by state governments and semi-government securities, particularly electricity authorities and Telecom Australia, the government-owned predecessor of Telstra.
Through the 1980s and 1990s, changes in areas such as Loan Council agreements and financial deregulation changed how federal, state and local governments arranged their finances and that of their authorities, while the banks could be more aggressive on interest rates for their deposit raising.
The overall outcome was a sharp contraction in the availability of public sector securities to the retail investor.
This has not been filled by high-quality corporate loan securities available directly to retail investors. The ASX-listed income security market is a part response but this is dominated by quasi equity issues rather than debt.
Benefits of listed bonds
For retail investors the ASX market offers the opportunity to invest in AAA-rated Commonwealth Government-guaranteed securities at retail investor-size parcels in what should become a highly liquid market and at yields in line with institutional markets. The transaction costs will be in line with share trades. Investors can therefore build a diversified parcel of AGBs of varying maturities as they can build a diversified share portfolio.
But aspiring investors, and their brokers and advisers, will need to understand the potential risks due to the likely market price fluctuations as market conditions change. And with term deposits carrying the Federal Government guarantee of up to $250,000 per investing entity per bank, potential investors will have to weigh up the cons of the current lower yields on the AGB of the same terms, against the pros of the liquidity of a listed AGB.
Liquidity is important
Although the liquidity issue may seem a bit esoteric, in a financial crisis liquidity may be very important. At such times there can be no certainty that term deposits could be cashed in ahead of the stated term, or that the interest would continue to be paid on schedule.
But under those circumstances, as seen in recent years, there would probably be very strong demand for the certainty of Federal Government securities such as AGBs, with rising market prices. Investors might may well be able to cash in their AGBs at a profit while term deposit holders had to wait the full term.
Therefore, AGBs may well play a role in portfolios for certainty and liquidity as much as for interest yield. The importance of this liquidity and certainty was shown at times overseas during the GFC, when in the US and Germany, short and medium-term federal securities sometimes traded at negative yields. In other words, investors were prepared to pay more than $100 for the certainty of a future $100 being paid back by the government.
This market may also play a role in helping retail investors get a better understanding of the risk-return trade-offs with other fixed-interest offerings such as commercial property mortgages.
Aside from the specific opportunities for retail investors, the AGB market could be the forerunner to the development of listed markets in other fixed and variable rate securities issued by state governments; public and private infrastructure entities; and private and public companies. There is already a substantial listed market in income securities but, as noted, these are generally variations on quasi equity, with the risks faced in a crisis.
Retail investors gaining the experience of holding and trading Australian Government Bonds as pure debt securities could well act to encourage interest in a broader range of debt issuers. Just as many Australians became more interested in the sharemarket after receiving their first shares as a result of demutualisations of insurance companies such as AMP, and the floats of the Commonwealth Bank and Telstra, so a broader listed debt market could be stimulated by the AGB listings.
Benefits for retirees
By providing a more diverse set of potential investments, this would be of benefit to the rising number of retirees seeking a liquid and low-cost alternative to shares; and in turn, high-quality alternatives to term deposits as their main fixed-interest option. Fixed-interest managed funds and annuities are available, but are often illiquid and costly.
Brokers and advisers should consider more seriously how the listing of AGBs can help their retired clients create their own low-cost annuity structures inside self-managed superannuation funds and superannuation wraps. Listed AGBs now make it easier and less costly to create a mix of term deposits, AGBs and, in time, corporate debt securities.
That would provide a retiree with certain and periodic cash flows from interest payments and maturity proceeds. These flows could be much more tailored to an individual retiree's specific needs than the off-the-shelf annuities currently offered.
In particular, the inflation-indexed AGBs could offer retirees the certainty of very long-term inflation-protected and government-guaranteed income streams.
While retiree investors would face the potential price volatility of the AGBs, they would have the advantage of high liquidity not available through managed fund annuities.
Opportunities for intermediaries
This area is a significant new opportunity for brokers and advisers in meeting the needs of the increasing number of clients looking for income certainty in a low-interest environment.
The other side of this appetite for income and high-quality debt is likely to be the increased opportunities for funding by the public and private sectors directly to the retail market. An efficient and low-cost listed debt market may well provide an alternative to bank finance for relatively small businesses and private and public sector projects.
There would need to be the appropriate regulation and investor protection, as with the listing of shares.
Looking at the specific opportunities, such markets may provide future avenues for raising funds for the development of the port, rail, water and power infrastructure needed across Australia to support resources and rural industries. Or for the water, power, sewerage and transport infrastructure needed for residential property development.
This is particularly in an environment when retail investors like the idea of being able to literally touch and see working the assets their funds have helped create, rather than have them concealed by the veil of the managed fund.
Much will depend, however, on the role brokers and advisers play in helping their clients understand how the Exchange-traded AGB market can play a role in developing and diversifying portfolios.
About the Author
Darryl Gobbett SF (FINSIA) MSAA holds the positions of Managing Principal, Responsible Officer, Chief Economist and Adviser, at Prescott Securities Ltd. He has held senior management and advisory positions in the federal departments of Treasury and the Prime Minister and Cabinet; BankSA and Adelaide Bank; and Access Economics.
Learn about the basics of Exchange-traded Australian Government Bonds in this short ASX tutorial.
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