AUSTRALIASIAN INVESTMENT REVIEW - SPECIAL REPORT Constantly evolving Australian fixed income market attracts long-term investor interest
THE Australian bond market has been a popular haven for overseas investors in recent years, buoyed by some fairly strong relative attractions, such as Australia's AAA credit rating and higher interest rates than the bulk of the developed world - although currency headwinds have dampened the desirability of Australian bonds more recently.
The bond market has also been a beneficiary of Australia's large investment and savings pool, which attracts an increasingly broad range of issuers. The shifting interplay of these factors, which was a key theme at the recent Commonwealth Bank-hosted 8th annual Australasian Fixed Income Conference, means the local market is "constantly evolving", says Adam Donaldson, executive director of Fixed Income Research, Institutional Banking and Markets, Commonwealth Bank. 
"In Australia, we continue to have a cash rate at 2 per cent, and there's an ongoing debate about whether that will decline, but that's still 2 per cent higher than in most other advanced economies around the world - and in some of those destinations bond yields are actually negative, or close to it. So Australia still offers reasonably attractive spreads in the front part of those yield curves. Further out, our 10-year bond yield is nearly 3 per cent, and on a global scale that's still highly attractive," Donaldson says.
Market data shows foreign interest in Australian bonds has "tailed off" this year, but Donaldson says this is a combination of global investors being fully invested, and the fact the falling $A is now a disincentive to buyers. "We recently hosted over 50 leading global fixed income investors with over $3 trillion in funds under management, and the sentiment among these investors is that they still perceive the value to be there for the Australian market. Most of them say they are full-weighting now, but we still expect appetite to strengthen again when it is clearer the $A is near bottom," he says.
The Australian bond market is going through an "interesting broadening and deepening", he says, with activity in a number of areas. First, the Australian Government, through the Australian Office of Financial Management (AOFM), is adjusting its issuance strategy to pursue more long-dated bonds. "In 2013, the AOFM issued a 20-year bond, and last year it issued a 24-year bond, which is the longest-ever maturity for an Australian government bond. These issues attracted very strong demand among both domestic and foreign investors, who've shown that they're very keen to invest beyond 10 years in Australian sovereigns," Donaldson says. "Domestic investors can't replicate that exposure by other means, so have been lifting exposure to government bonds." Second, he says, is the continued appearance of new borrowers in the Kangaroo ($A bonds for non-Australian-domiciled issuers) market - new corporate issuers, such as SABMiller, Apple and Intel, and supra-national issuers such as the World Bank, the Inter-American Development Bank, the Asian Development Bank and the European Investment Bank..
"Given that the Australian state governments have generally been consolidating their fiscal position, which means that the supply of semi-government bonds isn't very large at the moment, the global broadening of supra-nationals and high-quality corporate names coming to the market has given investors a newer and broader set of opportunities," Donaldson says.
The third major development is the nascent traction being gained by the long-mooted Australian retail bond market. Given that Australia has close to $600 billion in self-managed super funds (SMSFs) - an amount of which financial research firm CoreData believes just 4.9 per cent is held in fixed-interest - this development is "long overdue," says Steve James, head of Advised Distribution Investor Sales, Institutional Banking and Markets, Commonwealth Bank.
"We've seen a bit of a revolution in the fixed-income market in that it's been opened up a bit, as a lot of work has been done to break down the parcel sizes of wholesale bonds to suit retail investment - particularly SMSF investment - and there has been quite a bit of listing of fixed-income exchange-trade funds (ETFs) and exchange-traded bonds (XTB) products on the Australian Securities Exchange (ASX)," James says. "We're just seeing the start of people having the opportunity to consider whether they want to be a shareholder in a company or lend money to it." By international standards, Australia is behind other jurisdictions on this kind of investment, James says. "Australian investors don't generally buy bonds, but in most other developed countries, investors do. It is another element of diversification, investing on the other side of the balance sheet. Here, retail investors tend to see term deposits as their main interest-bearing investment: in New Zealand for example, many investors buy bonds instead of term deposits." Admittedly, James says, Australia has regulation in place including the Corporations Law requirements and sophisticated-investor hurdles for retail investors contemplating the fixed-income markets, but he says the landscape is changing, as products such as single bond ETFs emerge and structuring technology is applied to fixed-income product development.
Sophisticated investors who are looking further afield as term deposit rates have fallen with the cash rate - but who lack the funds to enter the wholesale bond market - can now access 53 XTB issues listed on the ASX, made up of 21 Australian government fixed-rate bonds, seven Australian government inflation-linked bonds, 22 floating-rate corporate bonds and three fixed-rate corporate bonds, totalling $446 million in capitalisation. In fixed-income ETFs, there are 10 bond ETFs and one cash ETF, with a total capitalisation of $1.8 billion.
"It is only very early days with the retail bond market, but I think we're going to see enormous growth," James says.
"We've got an ageing population coming through, we are very likely to see people say 'well let's reduce the equity volatility component of our portfolio and perhaps worry more about the protection of our capital.' From that we think defensive assets will expand their place in the portfolio, and fixed-income assets will play an increasingly important role."It is up to us in the industry to apply the marketing horsepower and investor education as work with work with the relevant regulators to make fixed income investing more accessible."