The search for bond yields

Glenn Freeman  |  27/09/2016Text size  Decrease  Increase  |  

Glenn Freeman: I'm Glenn Freeman from Morningstar and I'm joined today by John Likos, our senior credit analyst.

John, thanks for joining us.

John Likos: Good to be here.

Freeman: Now, John, global bond yields have been at historic lows. How has that flowed on and affected Australian investors?

Likos: I think the low interest rate phenomenon has effectively transcended upon Australia as well. So what we found is, as the global benchmarks become lower in their rates then investors tend to chase the yield a bit more aggressively. So this whole 'search for yield' theme has been rolling on and almost increasing as yields continue to fall. So, as long as global yields do continue to fall, we'll find the search for yield theme will remain quite strong.

And what that does is it compresses yield. People chase after yield, prices become higher and therefore, yields go lower. So, we've been seeing it recently, there has been a bit of a slowdown in more recent months, but it's still a very search for yield centric theme.

Freeman: John, you're speaking at our upcoming Morningstar Individual Investor Conference. Can you just give us some early insight into what you'll be discussing there?

Likos: Yeah. Look, because my responsibilities really are around credit-based securities and interest rate sensitive securities you find that bond yields are generally behind a lot of the moves.

So we will be discussing the impact of this search for yield thematic upon Australian hybrid securities and credit securities. We will be looking at securities that we believe are most vulnerable to yield shocks.

In other words, if yield to turn around and go back up, which securities would be most impacted negatively, which ones would be least impacted? So we will be making some suggestions in terms of what we believe are the best ways to position yourself in an environment where the yield does actually turn around and start increasing.

Freeman: John, Morningstar has recently released its first ever Hybrid Handbook. Can you just talk us through a little bit about what that entails?

Likos: Yeah. Look, over the years at Morningstar, we continue to get a lot of questions surrounding a lot of the intricacies of hybrid securities. They are very complex securities in short. There's a reason why the prospectuses are 150 to 200 pages long. There's a lot of explanation that need to be put in there, a lot of risks that need to be highlighted. What we found was we would get a constant stream of similar questions from different clients.

So we thought it would be very useful for our investors to actually put together a bit of a handbook, almost kind of a dummy's guide to hybrids in a way where we outlined just how hybrids work, how they have evolved in Australia over the years, what some of the key risks are and then we're going to a section where we actually outline the securities under our coverage. We discuss them on a one-by-one basis, some of their key features, some of their key contractual features and some of their key terms.

So, look, it's never been done before in this way within Australia. So we're quite looking forward to receiving the feedback, which we think will be very positive. And going forward, we intend to continue to publish this and continuously improve it at the same time. So there will be things we will adding on. There might be things we'll be taking out. So we'll be discussing this at greater length at the Investor Conference.

Freeman: Now, just lastly, in Australia's hybrid space, there's a high concentration of banks. How can investors access good diversification here?

Likos: Yeah, that's true. The majority of hybrids in Australia are issued by the big four major banks. Now there's different ways investors can diversify. They can diversify within the actual four bank exposure.

There are still some oldest style notes which have different features than some of the new style notes. We make these points quite clear in our analysis.

Or another way they can diversify between the big four banks is they can go shorter in terms of their expected duration or they can go longer. There are some notes which have longer terms; there are some notes which have shorter terms.

So, once again, we'll discuss these concepts at length in our analysis and sometimes our preference is change in line with the market around us.

Otherwise, there's corporate names as well and unfortunately, Australia has a shortage of corporate hybrid names.

We'd like to see more out there. We are seeing Origin Energy; we are seeing Woolworths calling their notes at the end of this year. At this stage, neither has suggested they are going to replace them. So that's two fewer corporate names that we do have out there.

Nonetheless, there are still some good corporate issuers. Goodman, for example, is one that we do particularly like.

Freeman: John, thanks very much for your time.

Likos: Thank you.

Freeman: I'm Glenn Freeman from Morningstar. Thanks for watching.

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