Investors: better safe than sorry?

A year ago, term deposit investors were in heaven. Eight per cent-plus returns were par for the course and investors could revel in high returns for very little risk. One of the more generous deals on offer was the Macquarie Olympic special offering — 8.88 per cent for eight months — a deal that might have signalled the top of the market.

However, times have changed. With interest rates dropping 4.25 per cent in the past year, term deposit rates of 8 per cent are now a pipe dream. The days of a risk-free high return like this are over. Many investors who have term deposits that are maturing are still looking for these returns; however, the only way to get them is to take on more risk. So where can such returns be found?

Bank securities

The obvious answer is to stay invested in bank securities, but investors will have to be placed lower down the capital structure than a government-guaranteed term deposit. For investors able to purchase bonds with a $500,000 face value, long-dated major bank subordinated debt provides returns of close to 8 per cent. For those willing to take on slightly higher risk, the subordinated debt of the regional banks can see investors earn

closer to 10 per cent.

For the more retail-orientated investor, bank hybrids may be the way to go. Strangely, even though these securities sit behind subordinated debt on the capital structure, they currently offer lower returns. Investors will struggle to get a return of close to 7 per cent at current prices for the major bank hybrids. However, for investors willing to take on some additional risk and venture into regional bank hybrids, returns of 10 per cent are quite easy to find.

Another option is to purchase the senior debt of international banks. While most of these banks have more operational and capital issues than our strongly-positioned local banks, senior debt ranks above that of subordinated debt on the capital structure and hence has priority of payment. Due to the current concerns over international banks, which we think generally are overstated, returns of 8 per cent are quite easy to find in international bank senior debt.

Investors who are willing to step up the risk curve and invest in the subordinated debt of the international banks will be able to earn returns well in excess of 10 per cent, depending on the risk of the issuer.

For those who don’t want to move away from term deposits, while they won’t earn returns of 8 per cent, there are still select opportunities to earn close to that. The trick is to invest large amounts in long-dated term deposits. Most institutions are only offering rates of up to 4.5 per cent for under a year. However, for those prepared to invest more than $150,000 for a five-year term, rates of over 7 per cent are available.

Bonds

Another option for investors looking for 8 per cent returns is to look at Australian corporate bonds. Once again, though, investors in these securities will need at least $500,000 to purchase these securities.

Investors can currently earn returns of close to 8 per cent by investing in the debt of highly-rated corporates such as Telstra. For those who aren’t scared of overseas names, AXA, Swiss Re and GE Capital also have bonds

offering outstanding value and a high credit rating.

However, the real value at the moment probably lies in beaten up property bonds. Property is on the nose at the moment due to declining values and liquidity issues with the banks. However, most of the property companies have now de-leveraged their balance sheets via significant equity raisings, vastly reducing the risk associated with them. The good news is that the bonds of these companies are all still offering exceptional yields, with returns of at least (and in some cases significantly in excess of) 8 per cent available on GPT, Mirvac and Stockland debt.

Retail bonds

One of the few positives of the global financial crisis is that it has seen the reopening of the retail bond market. This market allows investors who don’t have the $500,000 needed to access the institutional bond market to invest in the ASX-traded debt of highly-rated corporates.

So far the issuance of these securities has been slower than expected, however, there have been two bonds issued by highly rated corporates — AMP Notes and Tabcorp Bonds. When initially issued to investors, both these securities were offering returns of close to 8 per cent. However, after a strong rally in price subsequent to listing — the AMP Notes are currently trading at around $107 and Tabcorp Bonds at approximately $103 — the returns on these securities have diminished.

It was expected that there would be a slew of retail bonds issued to investors after these initial issues; however, the market hasn’t taken off as anticipated. There have been few subsequent issues of such securities, although at least when they do come to market they are still offering solid returns.

Recently, Brookfield Multiplex announced a three-year property bond secured over a low-risk new commercial building tenanted by the Australian Taxation Office. The bond will offer a return of around 8 per cent. While it doesn’t offer the safety of a term deposit, due to the quality of the security involved, it is reasonably low risk and does hit the magical return threshold.

Government debt

The final option is for investors who are prepared to accept a lower return than eight per cent but don’t want to significantly increase their risk. The various types of government debt are the obvious answer in this situation.

We’ve been advocating the merits of investing in inflation-linked bonds for some time, and, with the risks of inflation rising markedly in coming years, it is still an attractive option. While no formal announcement has been made in relation to ‘linkers’, speculation has been mounting for some time about the Government reintroducing these securities — and we would expect news on this front is imminent.

Semi-government bonds are the other standout investment at the moment. All state government bonds carry either AAA or AA+ credit ratings, making them relatively secure investments. Again, investors are being rewarded for ‘going long the curve’ with semi-government debt. While 8 per cent is definitely of reach, investors should be able to get returns of around 6.25 per cent by investing in these securities.

Finally, there are AAA-rated Commonwealth Government bonds. While these securities offer lower returns than semi-government bonds, they are also lower risk. Again, investors are being rewarded for investing in the longer-dated securities, in this class with five-year Commonwealth Government bonds currently yielding about 5 per cent and 10-year bonds approx-imately 5.5 per cent.

Summary

The good old days of an easy, risk-free 8 per cent return are over. However, for investors willing to take on slightly more risk, those returns are still available. Conversely, for those who want to play it safe, returns close to that level are available in the right investments — especially those with longer durations.

Brad Newcombe is a senior research analyst at FIIG Securities.