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G & J

The case for global corporate bonds

Corporate bonds are issued by companies as a way of raising cash to fund their operations. They are essentially a different way for companies to raise debt away from a bank loan, or more typically a syndicated bank borrowing facility. 

The global corporate bond market is roughly NZ$22 trillion dollars, according to S&P Dow Jones. New Zealand barely registers at just 0.1% of the total at around NZ$22 billion. In fact, America’s bond market alone is 500 times the size of ours. Unlike the New Zealand debt market, it’s large, it’s broad and it’s deep.

Our bond market is shrinking away even as Kiwi companies are finding it cheaper to fund themselves via private arrangements with pension and insurance funds outside of NZ. Since the global financial crisis, companies have been focused on reducing their debts which means they haven’t been issuing as many bonds. And of course, since the GFC, in NZ we have a steady supply of KiwiSaver money looking for a home. Unsurprisingly, given the net effect of lower supply and greater demand, the extra interest payment that a company has to pay above government bonds – the credit spread – has been decreasing for over a year. Effectively this means prices of existing corporate bonds are being bid up.

It is becoming incredibly hard for all participants in the NZ corporate market to buy the kind of bonds we want to buy at prices that make sense. There are simply not enough quality New Zealand debt issues to go around.

The NZ market is not particularly diversified. Just over half of corporate bonds have been issued by banks, with State Owned Enterprises like electricity companies and Local Authorities not far behind. When you don’t diversify your investments, you end up prone to shocks. You only have to think about the political football of electricity prices to give one pause on how many electrical utility bonds you want to own. It’s good to spread your risks around.   

We consider the best way to create truly diversified portfolios is to buy corporate bonds managed by foreign fund managers. There is a strong demand for income right around the world as populations age in developed nations. Other countries have a wall of retirement money looking for income too and that means their credit spreads on bonds in those markets may also be quite small. However, in our view there are many, many more opportunities to buy the bonds of good quality companies in global bond markets at reasonable prices in reasonable size. 

One thing that investors need to consider is the impact of rising interest rates. Global bond funds typically have a longer duration than New Zealand bond funds, so in theory they are more likely to potentially lose capital than New Zealand bonds. However this may be countered by the additional risk protection measures that global managers have access to.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.