Where the "smart money" is buying in corporate bonds

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As global economies start to normalise, themes around travel, tourism and retail commercial property have been lucrative trades for equity investors but they are increasingly crowded. 

There are other ways for Australian investors to gain exposure, and the opportunities are growing at a healthy clip, explained Income Asset Management’s Matthew Macreadie in a recent interview.

Australia’s corporate bond market has long been regarded as illiquid and overly-concentrated but the reality is now far different, said Macreadie, Director of Credit Strategy for the fixed income fund manager.

“It has become a lot more liquid, is now issuing 10-year bonds and is seeing oversubscriptions of two to three times in some of the primary deals on offer,” he said.

“Year-to-date there’s been about $16 billion dollars in corporate issuance here, up around 30% on 2020, and we expect this to total about $20 billion for calendar year 2021.”

Around 40 local firms have issued bonds this year, including several household names, including:

  • Wesfarmers
  • National Broadband Network
  • Pacific National Holdings.

In the following interview, Macreadie points to red flags investors need to look out for. Warning against being seduced by potential yields, he urges credit investors to “look at the risk first and then the returns.”

Macreadie reveals several sectors of high-yield credit he expects to outperform in 2022, and also discusses three big Australian corporates he’s watching closely into next year and beyond.


Edited transcript

What trends are you seeing in the bond market?

The Australian corporate bond market has really developed over the years. The global corporate bond markets have been strong and had large volumes for a number of years. But the Aussie market has always been viewed as illiquid with small tenor sizes and low levels of market participation.

Now, in our view, this has changed. You're starting to see Australian corporates issuing 10-year bonds. You're now seeing oversubscriptions in new primary deals of two to three times. You're also seeing a vast array of issuers come to the market.

In 2021 year to date, you've seen around $16 billion in corporate issuance, which is up around 30% on 2020 year to date. 

We expect the 2021 calendar year to be about $20 billion in total, a lot of these issuers have been utilities and REITs.

For the overall 2021 year, we've seen about 40 corporates come to market. Some of these have been household names like Wesfarmers, NBN, Pacific National, and then you've had some high-yield names on there as well, including Peet, Money Me, as well as Emeco.

What we also saw this year was Wesfarmers do a sustainability-linked bond. That's quite interesting because we're now seeing ESG investors come into the corporate bond market alongside real money investors, superannuation funds, policy funds and SMSFs.

The Wesfarmers bond had two ESG-linked performance targets. One was a renewable energy reduction and the second was a carbon emissions reduction. So this is an interesting deal that we saw.

Where is the ‘smart money’ buying?

Like equities, there are some sectors that were affected by COVID (and the GFC) and those same sectors also apply in the bond space.

Sectors like travel, tourism, hotels, distressed debt and retail REITs on the equity side, which are coming to fruition as what we call 'reopening trades'.

On the bond side, there're also reopening trades where those bonds will be offering quite a good yield once the economy starts to normalise and come back of fruition.

We think there're some sectors in REITs, one example of which is Scentre Group, where you've had rents that fell during COVID but the bonds also widened on that investment. But as the reopening occurs and Sydney and Melbourne come out of lockdowns and restrictions fall away, you should see rents start to pick up and those bonds should outperform some other sectors.

A lot of these are in the higher yield space than the investment-grade space, partly due to those sectors being more cyclical and more affected by COVID.

How can investors avoid bad outcomes when investing in credit markets?

There are a couple of key takeaways that I keep in mind when I'm doing my credit analysis on certain bonds and issuers.

Credit ratings generally aren't a good predictor of default. Agencies are there to rate credit, but they can discount certain issues that companies are having and they don't accurately predict default risk.

Debt structure matters when you're looking at a credit. So for example, with something like Virgin, there was a high amount of senior secured debt in the structure. For an unsecured creditor, that should have set off alarm bells. When you look at the recovery value on the Virgin bonds, it would've been less than what you would've expected had you been a senior secured creditor.

Look at government support. Some credits have implicit government support. Others have explicit government support. Now a good example in this current environment is Evergrande

So they're going through a lot of issues in China, in the property development space. A lot of the market has expectations that the government will bail out a lot of these property developers.

Bloomberg came out with an article recently saying two-thirds of property developers are actually in trouble due to the new debt laws that China's introduced. This means that these property developers have more liabilities than assets and significant liquidity problems.

There are a few key things to take away from both the Virgin and Evergrande examples that can be applied to the high-yield debt market to make sure that you, as an investor, don't lose your capital in the long run.

What went wrong in those two cases?

What went wrong in both cases, was that they were both cyclical credits which were valued or priced based on a yield, that looked at forward-looking earnings. However, if investors can't get comfortable with forward-looking earnings, then it's not a credit you should be a part of.

A lot of the time, investors look at a yield of 9 or 10% and get seduced by that yield. What they don't do is the actual fundamental analysis on the credit, they don't look at the risks.

So my advice to investors would be look at the risk first and look at the return later. If you focus on the return and the 9 to 10%, you're likely to miss something and lose your capital.

Can you share some compelling opportunities that Income Asset Management has identified?

Pioneer Credit: PIOCRE 0 22/03/23 MTN

Pioneer is a distressed credit player. They buy distressed loans and then turn them into basically performing loans by restructuring their payment arrangements and also working with the borrowers to make sure they're performing.

Pioneer was hurt quite a lot during COVID where they weren't able to refinance one of their bonds. But they've turned the credit around. They've raised equity and they've restructured their capital.

We are looking forward to the market evolving to the point where banks will be giving up some of these distressed loans and selling them at 20 cents to the dollar, which should provide upside for a name like Pioneer.

Pioneer can transform those loans into better-performing loans and now has the right environment to capitalise. Pioneer have a five-year bond out in the market with around a 9% yield and we think that's a nice story given the reopening thematic.

Crown Resorts: CWNAU 0 23/04/2075

The second one we have been looking at recently is Crown, which issued some ASX hybrids recently. The other week, the Melbourne licence was renewed for a further two years, which gives Crown some visibility over its cash flows and revenue profile.

As state economies open up, we're going to see people go back to casinos. Consumers like to spend their money at casinos, and so we should see the Crown bonds perform all else equal.

They're offering a 10% yield in the current environment, which is very good compared to some other high-yield and investment-grade bonds.

Capital Alliance Investment Group (CAIG): CAPAAU 10% 21/10/2025

The third idea we have is CAIG (Capital Alliance Investment Group). It's a Melbourne based hotel group with three assets which are currently operating and two in construction (these are five-star hotels). It offers a 10% yield.

Again, as the state economies open up, consumers will want to travel and they want to stay at good hotels.

So coming out of COVID that's something that will be very important for people. They don't want to stay at two or three-star hotels. Thus we think that the cash flow and revenue profile should be good for a bond investor going forward.

How can investors access the bond market?

Traditionally, it's been very hard for retail investors but they could buy bonds on the ASX. There's a small amount of bonds where they can trade, but not to the volume needed.

Now, the Chair of Commission of the Standing Committee has come up with 12 recommendations under the House of Representatives to try and increase retail participation in the bond market by allowing $1,000 parcels. But this is still some way off.

As a wholesale investor, the best way to access the bond market is through IAM's direct bond investment service or through a fund, which we offer via Fortlake Asset Management.

IAM has access to over 150 small parcel bonds available in parcels of $50,000 because the ASX listed bond space is just too small and there are not enough bonds for retail, it's really difficult for them to get the position they want. 

Learn more about Income Asset Management

IAM offers sophisticated investors direct access to over 700 corporate bonds. If you’re interested in learning more about how bonds play a role in your portfolio please visit our website for more information.

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