Fixed income gains interest in Australia

Australia has one of the highest concentrations of equity investments compared with fixed income anywhere in the developed world. But interest in ‘fixed interest’, as it is often termed down under, is growing. Christopher Jeffery reports

Investors, distributors and issuers gathered at the Westin hotel in Sydney on April 28 for Asia Risk’s Australian Fixed Income Forum. Their objective was to discuss and debate developments in the fixed-income business, including the macroeconomic forces shaping the Australian market, trends in debt financing and securitisation, the outlook for corporate and kangaroo bonds, the build-out of the linker market, and the relative trade-offs between government and semi-government debt.

The day started with a chief economists’ panel comprising Michael Blythe from the Commonwealth Bank of Australia, Scott Haslem from UBS and Stephen Roberts from Nomura, who are all based in Sydney, and moderated by QIC’s Brisbane-based chief economist Matthew Peter. The economists made predictions about the impact of the macroeconomic forces shaping the fixed-income markets in Australia, including how proposed new financial regulation will likely distort markets and act as a potential drag on economic growth.

But the discussion moved swiftly on to the previous evening’s decision by Standard & Poor’s to cut Greece’s sovereign debt credit rating to junk – a subject that was keenly debated throughout the day. “Greece almost certainly will get the funding it needs for the May 19 bond payment of E8.5 billion ($12.3 billion), but it might take a week or so, which means in Europe we will have a lot of volatility,” said UBS’s Haslem. He added that, politically, Greece could not be allowed to default in the short term. “On a longer-term basis, it is a very difficult situation and, one or two years down the track, debts and defaults are much more likely,” he said, echoing the thoughts of many market participants at the event.

Later on in the day, Jon Addison, chief investment officer of the Meat Industry Employees’ Superannuation Fund, based in Melbourne, expressed investor concern about the role of rating agencies in the fixed-income markets. “We also have to worry about the credit rating agencies – I do not think they have served us as well as they should have done. They have been rating things as AAA that patently weren’t, and then when they start downgrading, they start over-downgrading,” he said. “To suddenly move on Greek sovereign debt and classify it as junk is verging on the irresponsible. One way or another, those debts will be serviced – possibly not by the Greeks, but they will be serviced.”

Addison said there were a number of investors that would become ‘forced sellers’ as they are restricted by mandate from holding sub-investment grade debt. “I never want to be in the position of being a forced seller. That is why whenever I decide credit limits it is always done at the time of purchase.”

He wasn’t alone in his criticism of the agencies. John Livanas, Amist Super’s Sydney-based chief executive, who heavily criticised the methodologies used for rating collateralised debt obligations, said “there is no way on the planet” that Greek debt is worse than the debt of than half the companies in the Russell 3000 Index. Livanas added that more generally, government bonds behave very differently to corporate bonds and that a little-known fact during the global financial crisis (GFC) was that government bonds acted as decorrelated investments, compared with corporate credit and equities. He said he had asked a student group to conduct an analysis of correlations during the GFC as well as at 10-year and 20-year intervals. “Credit correlations between equity and credit went to 1, but the correlations of government bonds and credit went from +0.2 to –0.5, which means that [government] bonds did exactly what they were supposed to during the GFC,” said Livanas. “The problem is that when we look at fixed income, we include credit.”

Meanwhile, speakers said the Australian securitisation market is looking more positive, but remains a far way off from 2006–07 heights. “Pricing levels have become more economic and the secondary market has reopened to some extent,” said John Sorrell, head of credit at Tyndall/Suncorp Investment Management in Brisbane. However, Tony Togher, head of short-term investments at Colonial First State Global Asset Management in Sydney, said the market is unlikely to return to peak levels any time soon. “If we go back to the peak of the market in 2006–07, about 50% of investors in asset-backed securities were made up of special investment vehicles (SIVs), 20% were banks and 30% real money. The SIVs are gone and the banks are more reluctant to purchase these securities, which means that even assuming real-money accounts are still purchasing the same amount, 70% of the money is gone. That is not likely to come back in a hurry,” he said.

Among the issuqes debated by panellists was the introduction of ‘skin-in-the-game’ requirements, which force securitisers to hold a set percentage of assets to create an alignment of interest. While in the US, lenders are required to retain at least 5% of the risk of

losses on asset-backed securities, panellists preferred a more principles-based approach to skin-in-the-game requirements in Australia. “If we start being very prescriptive on skin-in-the-game, then

all we will do is drive the smaller institutions out of the market because they just do not have the access to capital,” said Bruce Potts, investment director of debt investments at Industry Funds Management in Melbourne.

Moody’s Investors Service showed that while issuance of residential mortgage-backed securities (RMBS) dropped from A$57 billion ($51.4 billion) in 2006, to just A$6 billion in 2008, A$4.5 billion has been issued in the year to date. Crucially, the proportion of Australian Office of Financial Management (AOFM) contributions – which accounted for around 70–80% of transactions at the height of the global financial crisis – has dropped to around 20%, while a number of deals have also been completed without AOFM support. That indicates real money is making a tentative comeback.

“Investors are recognising the strong credit of Australia and they would like to invest in RMBS,” said Richard Lorenzo, vice-president for structured finance at Moody’s,  although he recognised the market remains a far way off from pre-crisis levels.