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Is there still value in bond proxies?

Emma Rapaport  |  22 Mar 2019Text size  Decrease  Increase  |  
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Bond proxies, or stocks that share some characteristics associated with fixed-income investments like infrastructure stocks and real estate investment trusts, have increasingly become a good option for investors seeking regular income.

Real estate investment trusts and utility stocks typically mirror bond market movements because of their high levels of and debt relationship to interest rates.

Their revenue is somewhat resistant to economic downturns compared with other sectors like consumer cyclicals because of the long duration contracts or their natural monopolies over essential services.

For investors, they can offer stable earnings, safe and predictable income, and revenue streams similar to bonds.

And over the past ten years, falling interest rates have spurred investment in bond proxies offering higher yields, rallying the stock prices of some bond-like equities.

But infrastructure equity analyst Adrian Atkins says some bond-like equities, particularly utility stocks such as Spark Infrastructure (ASX: SKI), have recently come under intense regulatory scrutiny, shifting the sector's dynamics.

Similarly, real estate equities analyst Tony Sherlock warns that retail landlords are facing rental growth pressure from ailing tenants, as the sector fights off weaker consumer spending and disruption from e-commerce players as sales shift online.

Both add that a return of interest rates to a more neutral setting could cause a negative rerating of all bonds and bond-like-equities, exposing investors to the risk of capital losses.

"We think interest rates will trend higher over the longer term, detracting from the attractiveness of income stocks," Atkins says.

Landlords: a source of sustainable earnings

But in an environment where global central banks are toning down expectations for an interest rate increases, which bond proxy stocks remain? Sherlock points investors towards conventional rent collector REITs such as GPT Group (ASX: GPT) and SCA Property (ASX: SCP).

GPT, he says, offers investors exposure to a diversified portfolio of commercial (office and industrial) assets, primarily on the Australian east coast, which provide sustainable earnings with solid growth prospects. While the REIT has a meaningful weighting to retail property,

Sherlock says this is largely concentrated in prime Sydney and Melbourne assets.
SCA Property, or Shopping Centres Australasia Property Group, owns a portfolio of 85 smaller shopping centres, all anchored by Woolworths and/or Coles supermarkets, which make up half of rental income. Assets are predominantly in suburban fringe and regional areas of Australia and comprise neighbourhood (75% by value) and larger subregional (25%) shopping centres.

Sherlock backs SCA's decision to focus on convenience-based small malls, typically those with a major supermarket and 10 to 15 speciality retailers.

"Most of the assets owned by SCA Property are in regional Australia, a long way from the distribution hubs of the major online retailers," he says.

"This type of asset seems to be well insulated from online grocery retailers, who we suspect will find it uneconomic to offer same-day delivery to regional areas of Australia in the foreseeable future."

Sherlock says moderating growth in Australian household disposable income is a long-term headwind for all retailer landlords, but to a lesser extent SCA rents due to its focus on non- discretionary retail categories.

APA Group: potential for excess returns

In infrastructure, Atkins singles out owner and operator of natural gas and electricity assets APA Group (ASX: APA) as among the most bond-like. While it’s not immune to regulation, this is less of a burden than it is for APA’s peers.

"Australian household and business utility bills are rising strongly from already high levels, and governments are responding with sweeping measures," he says. "For APA, this includes gas market rule changes attacking the asymmetric information advantage helping it secure excess returns."

Atkins says investors could find stability in leading toll road owner/operator Transurban Group (ASX: TCL), which offers exposure to a portfolio of assets in Australia and North America.

"Concession lives are fixed, with toll roads handed back to their respective governments debt-free at the end of the concession," he says. "The weighted average concession life of the portfolio is around 30 years.

"Toll roads have high barriers to entry and benefit from rising traffic volumes and tolls, which increase in line with the consumer price index or higher."

is a reporter for Morningstar.com.au

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