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Roger J Kerr says the conditions are currently ripe for both corporates and investors to reap a mutually beneficial harvest

Bonds
Roger J Kerr says the conditions are currently ripe for both corporates and investors to reap a mutually beneficial harvest

By Roger J Kerr

Investors always have choices as to how they weight their portfolios between the investment asset classes of equities, property and fixed interest securities/bank deposits.

Due to very low interest rates over recent years many investors switched their money away from fixed interest securities and bank deposits into NZ shares and property. The weight of investment flows into these two asset classes certainly contributed to impressive capital gains over the last five years as the charts below confirm.

Is there now a risk of the music stopping for equities and property after five years of spectacular investment returns?

The question is how much will rising interest rates over the next few years would take the gloss of equities and property and cause a switch back to fixed interest securities and bank deposits? In other words, how high would corporate bond yields or bank deposit interest rates have to be to attract funds back from shares and property?

I do not have the definitive answers to these questions, however my sense is that many investors will be looking to cash-up their property and equity gains, reduce market related risks and seek the safety of corporate bonds returning around 5.00%.

It may take a bit longer to get bank deposits up to these levels.

Contact Energy recently issued a 6-year bond at 4.40% (1.50% over the swap rate) which was snapped up. Wellington International Airport issued an 8-year bond at 1.60% above the swap (= 4.90% all up) which did not attract the same level of intense investor demand.

It would seem that BBB rated (or equivalent) corporates could issue 7-year tenor bonds at near to 5.00% all up (3.20% + 1.80% margin) and attract plenty of investor interest.

The market window of opportunity for corporate borrowers to tap the non-bank debt market (for a tenor longer than what banks offer) may be open again and should be taken advantage of.

A smartly priced corporate bond is one that both issuer and investors come away from the transaction well satisfied.

These conditions appear ripe for both parties currently.

Daily swap rates

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Source: NZFMA
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Source: NZFMA
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Source: NZFMA
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Source: NZFMA
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Source: NZFMA
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Source: NZFMA
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Source: NZFMA

 

Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

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4 Comments

The question is how much will rising interest rates over the next few years would take the gloss of [sic] equities and property and cause a switch back to fixed interest securities and bank deposits? In other words, how high would corporate bond yields or bank deposit interest rates have to be to attract funds back from shares and property?

Hmmmm...

A few quick notes - we’re hearing the perennial arguments about “cash on the sidelines” waiting to gush into stocks. As always, one should remember that every security that is issued in the financial markets has to be held by someone, in precisely the form it was issued as (currency, Treasury bills, commercial paper, stocks, bonds) until that security is retired. What people observe as “cash on the sidelines” is nothing other than a mountain securities that have been issued in the form of short-term money market instruments, and those instruments will remain “on the sidelines” until they are retired. In the meantime, every single one of them will have to be held by someone. They do not “flow” anywhere. They simply change hands, and changing hands doesn’t affect their quantity.

All securities are priced, and their returns are determined, to ensure that every security that has been issued is held by someone at every moment in time. Prices and expected returns can change in an instant, without any material volume of transactions. All that needs to happen is a change in the relative eagerness of investors to hold one security versus another. Read more

Furthermore,

“Understand that securities are not net economic wealth. They are a claim of one party in the economy - by virtue of past saving - on the future output produced by others. Fundamentally, it's the act of value-added production that ‘injects’ purchasing power into the economy (as well as the objects available to be purchased), because by that action the economy has goods and services that did not exist previously with the same value. True wealth is embodied in the capacity to produce (productive capital, stored resources, infrastructure, knowledge), and net income is created when that capacity is expressed in productive activity that adds value that didn't exist before.

“New securities are created in the economy each time some amount of purchasing power is transferred to others, rather than consuming it. Once issued, all of these pieces of paper can vary in price later, so the saving that someone did in a prior period, embodied in the form of some paper security, may be worth more or less consumption in the current period than it was initially. That’s really the main effect QE has - to encourage yield-seeking speculation that drives up the prices of risky securities, but without having any material effect on the real economy or the underlying cash flows that those securities will deliver over time. Read more

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Kiwibank:
"...NZ Post Guarantee will be terminated for new investments (term deposits) on 28 February 2017".
So, its only 1 (or is it 2) days to go now....

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A corporate bond at 5% held for 6 years is a "bargin"? oh boy.....

If nothing else what does that say about investors view of interest rates?

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Have NZers really shifted into equities? Of course, the introduction of Kiwisaver suggests that they have, but if there is any solid research or data showing how they have moved into this asset class, it would be interesting to see.

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