New indices for debt securities

Photo of Philip Bayley By Philip Bayley

min read

Benchmarking tool to assess portfolio performance.

Australia Ratings has announced its new family of indices that track the price movements and returns of debt securities traded on ASX. Based on securities that are rated by Australia Ratings, the indices provide investors and fund managers with a benchmarking tool for assessing portfolio performance.

Australia Ratings was appointed by ASX Limited in late 2014 to assign credit ratings to debt and hybrid securities traded on ASX, under the ASX Debt & Hybrid Research Scheme.

Since then Australia Ratings has assigned credit ratings to most listed securities. This consists of an assessment of the creditworthiness (credit quality) of the security issuer and an assessment of the complexity of the security. The rating assigned thus consists of alphabetical and colour indicators.

The alphabetical indicator follows the typical rating scale of AAA, AA, A, BBB, etc, and the colour indicator follows Australia Ratings’ proprietary Product Complexity Indicator (PCI) scale of Green to Red.

A PCI of Green is applied to simple, senior-ranking corporate bonds, while Red is used for the most complex hybrid securities – typically Basel III-compliant Tier 1 additional capital such as the various PERLS notes issued by the Commonwealth Bank. In between, various forms of subordinated debt are allocated PCIs of Blue, Yellow or Orange.

(Subordinated debt holders have lower priority for repayment than senior-ranking security holders should an issuer default. Thus subordinated debt holders take on higher level of risk.)

How the indices work

The family of indices consists of individual indices following the PCI scale, and a composite index that includes all securities tracked in the individual indices (see Chart 1, below). There are also sub-indices for securities that make franked and unfranked distributions (see Chart 2, below).

The indices are accumulation indices with a start date of 1 January 2015, which coincides largely with Australia Ratings’ appointment under the ASX Research Scheme.
The indices track security price movements and distributions since that date, and at present are compiled at the end of each month. This will change if demand warrants it.

Included in the indices are only those securities with a call or maturity date more than 12 months away, and only those with floating-rate distributions. The pre-tax equivalent value of the distribution is used when distributions are franked and each security is volume weighted.

Chart 1 - Index movements to the end of April 2016

Australian rating debt index chart

Source: Australian Ratings

The Blue index (relatively simple debt securities) has been the strongest performer. This index contains older-style subordinated debt issued by the major banks. The subordinated debt does not include a non-viability clause, which could force conversion of the debt into ordinary equity if non-viability is declared by APRA.

The Green index (simple bonds or notes) follows, but performance has been constrained by the lesser credit quality of the issuers (relative to the major banks) of these senior-ranking securities.

The performance of both indices will be affected by the relatively few securities included in each. Therefore, some volatility can be expected over time, especially as securities fall out of the index as the call or maturity dates approach.

While the price performance of constituents of the Red index (very complex debt securities) has been weak in recent times, it is the consistent credit quality of the mostly bank issuers that has held the index up. The Yellow and Orange indices (complex and more complex debt securities) have been adversely affected by the idiosyncratic factors affecting some issuers, such as Crown Resorts and Origin Energy.

The performance of the three indices has turned up since February with the return of more bullish investor sentiment. The Red index jumped by more than 2.5 per cent in April and the Orange index increased by 1.3 per cent.

The Yellow index was affected by the departure of the Colonial Group subordinated notes, which are due to be called at the end of March 2017.

The combined index is influenced by the larger number of constituents in the Yellow, Orange and Red indices. The index increased by 1.8 per cent in April.

Chart 2 - Franked and unfranked sub-indices

Franked and unfranked debt index chart

Source: Australian Ratings

Valuable performance benchmarking tool

It is expected that the Australia Ratings Listed Debt Securities Indices will become a valuable tool for individual investors and fund managers specialising in this part of the market, to measure and compare their investment performance against the combined index and/or relevant index.

Fund managers wishing to prove superior skill will no doubt be keen to measure their outperformance against one or more of the indices.

The indices will be published on Australia Ratings’ website soon after the end of each month.

Fund managers keen to use the indices for performance benchmarking should contact Australia Ratings on (03) 8080 6684.

About the author

Dr Philip Bayley is a director of Australia Ratings and the principal of debt capital markets consultancy, ADCM Services.

From ASX

The ASX Bonds page provides information on the features, benefits and risks of various debt securities.

The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

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