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Listed Debt Securities Indices Performance Review


Commentary:  2015-2016 Performance Review

The search for yield and lack of supply drive investors’ returns in 2016 and may do so again in 2017

Investors in ASX-listed debt securities have enjoyed strong returns in 2016. This comes as compensation for the poor returns experienced in 2015 and reflects the opposing forces driving the market in each year.

The search for yield, as interest rates continued to fall, and a lack of supply as redemptions exceeded new issues, particularly towards the end of the year, drove up prices among listed debt securities in 2016.

Indices Annual Returns in 2015 & 2016
Index Performance 2015, 2016 and total
Weighted average index yields 2015 to 2016
Outlook for 2017

It seemed 2015 suffered a hangover from the excesses of 2014 and earlier years. New issues had been abundant and credit margins had been steadily compressed.

This culminated in October 2014, when the Commonwealth Bank listed the $3.0 billion PERLS VII (CBAPD) hybrid notes, paying a credit margin of just 280bps over the 90 day bank bill rate. This was the largest issue and the tightest credit margin the market had seen, and it hasn’t been repeated since.

Credit margins widened throughout 2015 and into 2016, as the market digested supply and repriced credit risk. As a result, total returns to listed debt investors in 2015, ranged from modest to negative. Security prices generally fell over the year and positive total returns required distributions paid to exceed the fall in the price of the securities held.

Australia Ratings’ Combined index for ASX-listed debt securities shows a return of 8.04% for 2016. In 2015, the return was a negative 0.75%.

Indices’ Performance Review

Chart 1 presents the performance of each index over 2015, 2016 and in total.

Chart 1: Australia Ratings Indices Annual Returns - 2015, 2016 and total



Source: ADCM Services, Ord Minnett

Debt Securities’ Level of Complexity (PCI):
Green - simple; Blue – relatively simple; Yellow – complex; Orange – more complex; Red – very complex

The Red index has generated the strongest returns in 2016 and indeed over 2015 and 2016 combined, but has also seen the greatest volatility. The total return over 2015 and 2016 is 10.02%, being the product of a return of 9.96% for 2016 and just 0.05% for 2015.

The Red index encompasses the highest risk debt securities listed on the ASX. The Green index encompasses those of the lowest risk, yet this index is the second best performer with a total return over 2015 and 2016 of 8.39%.

The total return for the Green index is made up of returns of 0.77% and 7.56% in 2015 and 2016, respectively. It is arguable whether the difference in the returns from the Green and Red indices is commensurate with the difference in risk between the indices.

It is also interesting to observe that the less risky Yellow index has produced superior returns in both 2015 and 2016 to the riskier Orange index. And similarly, the Unfranked index has produced superior returns to the Franked index over the two year period.

Curiously there is more than four times the number of securities included in the red index than there are in the Green, Yellow and Orange indices. Does this suggest that issuers believe listed debt investors want only higher yielding securities or that only the riskiest debt securities are sold in this market because there is little or no demand in the wholesale market?

Australia Ratings’ family of indices’ performance over 2015 and 2016 is shown in Chart 2.

Chart 2: Australia Ratings index performance 2015 to 2016

 

 

Source: ADCM Services, Ord Minnett

 

A sharp uptick in performance between November and December 2016 can be seen in each of the indices. Origin Energy redeemed $900 million of subordinated notes (ORGHA) in December, while Insurance Australia Group issued just $404 million of capital notes (IAGPD).

This followed the redemption of $700 million of subordinated notes by Woolworths (WOWPC), just the month before. The holders of the redeemed notes have been looking to the secondary market for other investment opportunities.

Of course, as investors drive up security prices, returns in the form of yield to call/maturity are compressed, as can be seen in Chart 3 between November and December 2016.

Chart 3: Weighted average index yields 2015 to 2016

Source: ADCM Services, Ord Minnett

The weighted average yield for the Green index as at the end of December was 3.57% per annum. For the Yellow index the figure was 6.39%; the Orange index was 3.88%, and the Red index, 5.84%. The Combined index had a weighted average yield of 5.57% per annum. The differences in the weighted average yields of the Yellow and Orange indices reflects the presence of the longer dated, out of favour Crown Resorts Subordinated Notes II (CWNHB) in the Yellow index, and the relatively short term to call for the securities in the Orange index.

Outlook for 2017

Further secondary market price increases can be expected in 2017, as redemptions are expected to outstrip the supply of new issues by as much as $5.4 billion. Hopefully, this possible shortfall and consequent increase in investor demand will attract many new issuers to the market and thereby reduce the pressure on prices in the secondary market. And while any increase in interest rates will have little impact on the price of securities that pay floating rate distributions, any increase in risk aversion will also temper price increases.

For more information visit Australia Ratings Listed Debt Securities Indices.

 

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