Where to find attractive yield on ASX
A range of choices beyond shares for income seekers.
The Commonwealth Bank recently issued the PERLS VIII hybrid security, which is paying investors around 6.93 per cent per annum (after initially being issued at around 7.50 per cent) including franking credits. Compare this to CBA’s ordinary shares, which at present have a dividend yield of around 8 per cent including franking credits.
This comparison highlights two important points:
- The two securities have been issued by the same company but have different levels of risk.
- ASX now has an increasing number of yield products from which to choose, even from the same issuer.
Some of the yield investment options available on ASX include: government bonds, corporate bonds, hybrid securities, managed bond funds and exchange-traded funds. This article looks at the various yields available and how investors can assess whether they are suitable for their investment objectives.
In May 2015 the Reserve Bank of Australia cut the cash rate to 2 per cent, where it has remained since. Although there is much debate about where interest rates will move next, the markets are effectively pricing in a 0.25 per cent cut by the end of 2016.
A low cash rate feeds into the returns offered by many other products, thus making it harder for investors to find acceptable yields. Put another way, investors are having to take on more risk to generate the returns they were accustomed to in the past.
The capital structure
A key to understanding investment returns is knowing about the capital structure of a company. Companies raise money several ways: bank loans, equity and debt.
Equity holders are part owners of the company and get rewarded with dividends when the company makes a profit. However, they have no contractual right to receive dividends or even get their money back.
Debt holders, on the other hand, lend money to a company and hold a contractual right to receive regular interest payments and their money back on maturity of the loan.
Equity holders are taking the risk that the business will succeed. Debt holders are taking the risk that the company can pay its debts when they fall due. In a bankruptcy situation, secured debt holders are paid first.
Holders of a company’s securities are ranked according to how much risk they are prepared to take. Senior debt holders take the least risk and get paid first in the event of default. For this, they typically get the lowest returns. Subordinated debt holders get paid next and receive a little more in terms of interest for taking that extra risk.
At the end of line are equity holders, who get paid last (if there are any funds left over). Ultimately an investor has to work out if they are being compensated properly for the level of risk they are taking. The chart below shows how this works in principle.
When investors think about yield on ASX they typically think about dividend yields. In times of stress, companies can simply not pay dividends to shareholders. Also, share prices rise and fall, so investors are exposed to capital gains and capital losses.
In Australia, banks are among the highest dividend-yielding shares. In the example at the start of this article, the CBA dividend yield may look appealing but it has more risk and price volatility than the yield from CBA PERLS VIII.
Several listed company bonds are quoted on ASX, with a fixed or a floating coupon, usually a fixed margin above the Bank Bill Swap Rate (BBSW)). A floating coupon is particularly popular during rising interest rates because payments to the bond holder also rise. Unlike shares, bonds are guaranteed by the issuer to return capital and pay a regular income stream.
ASX also provides access to government bonds. These are mostly fixed rate and rated by markets as having the lowest possible risk. A three-year government bond yields around 1.90 per cent per annum and a 10-year bond around 2.55 per cent.
Floating rate bonds
A floating rate bond pays interest each quarter at a fixed rate above the BBSW, a benchmark rate published widely that is at present around 2.25 per cent. Some of the current floating rate bond yields include Origin Notes (8.35 per cent yield to maturity), Crown 2018 notes (14.95 per cent), Crown 2021 notes (13.23 per cent) and Suncorp 2018 notes (4.78 per cent).
The concept of yield to maturity is a complicated one and a fuller explanation can be found here on the YieldReport website.
The yield on the Crown notes has risen in recent months because of media speculation that James Packer may be trying to privatise Crown Resorts. Such a move would be seen as positive for equity holders but mostly negative for debt holders, and highlights the need to look beyond the headline yield to learn about the company situation.
One issue for investors buying bonds directly from an issuer or broker is that they are usually only available to wholesale investors. The Australian Bond Company has come up with an innovative way around this by holding single bonds in a trust and then allowing the units in the trust to be traded on ASX.
The product, called XTBs, has become a popular way to access corporate bond performance. Available bonds include Aurizon 2020 (4.44 per cent yield to maturity), Qantas 2022 (4.43 per cent) and Lend Lease 2020 (4.27 per cent).
Some of the highest-paying securities fall under the banner of hybrid securities. These have characteristics of shares and bonds but can be a little bewildering because of the nuances between each of them.
For example, some are perpetual securities, with the company having the option, but not the obligation, to redeem them at certain dates.
For our yield calculation purposes, we assume the companies exercise their option to redeem at the first opportunity. Bendigo 2020 hybrids pay round 8.40 per cent, Challenger 2020 around 8.20 per cent and Seven Network TELYS 4 around 12.80 per cent.
As noted, the CBA PERLS VIII hybrid is paying a yield around 6.93 per cent if held to maturity or date of first redemption. Compare that to the CBA PERLS VII offering around 7.43 per cent and you would rightfully ask what is the difference? They are essentially the same risk but the PERLS VIII is paying a higher annual interest rate than the PERLS VII.
The calculation of yield to maturity takes into account the security being redeemed at face value at the first redemption opportunity. In the case of PERLS VII, the securities are trading around $88.30. If they were redeemed at $100 the holder would receive this gain. This is included in the calculation.
Below is a chart of major bank hybrids and their yields.
Managed bond funds (through mFund)
An ASX initiative, mFunds, enables investors to apply for and redeem units in managed funds via their stockbroker. It was designed to allow investors to access managed funds more easily. So if buying and selling individual bonds looks too difficult, investing with a professional fixed-income manager via mFund might be the solution.
Funds such as the PIMCO Wholesale Global Credit Fund have returned 3.16 per cent over 12 months, Spectrum Strategic Income Fund 2.88 per cent and Aberdeen Diversified Fixed Income Fund 2.75 per cent.
Exchange-traded funds (ETFs)
ETFs are another way for investors to access the services of a professional fund manager but also with the ease of buying and selling units on ASX. ETFs have grown sharply in the past five years and make it easy for investors to switch asset allocations from a cash fund to a semi-government or government bond fund, or a corporate bond fund.
The best returns over the past 12 months have been from the BetaShares High Interest Cash Fund (2.57 per cent), the Russell Semi-Government Bond ETF (1.97 per cent) and State Street’s SPDR S&P/ASX Australian Bond ETF (1.83 per cent).
About the author
Matt Wilson is the CEO of YieldReport, an independent, free report that provides weekly commentary and analysis of Australia’s interest rate markets. He started his career in the fixed-interest markets before working in futures and derivatives for many years. You can register for free weekly updates here. (A note on franking credits: In order to compare apples with apples, the yields quoted above generally refer to the pre-tax yield or yield including franking credits. Prices quoted were correct at 20 April 2016.)
Matt Wilson is the CEO of YieldReport, an independent, free report that provides weekly commentary and analysis of Australia’s interest rate markets. He started his career in the fixed-interest markets before working in futures and derivatives for many years. You can register for free weekly updates here.
(A note on franking credits: In order to compare apples with apples, the yields quoted above generally refer to the pre-tax yield or yield including franking credits. Prices quoted were correct at 20 April 2016.)
To learn more about the features, benefits and risks of bonds quoted on ASX, and interest rate securities, take the free online ASX Bonds and Hybrids course.