If you’re looking for a safe area to invest, you might want to consider interest rate securities.
In volatile markets, many investors rely on these types of securities so they can look forward to receiving a fixed or floating rate of return as either interest or dividends.
There are a range of listed debt securities on the ASX like corporate bonds (which include convertible notes) and hybrid debt securities. So if you want to take shelter in the current sharemarket storm, read on as I take you through some key points to consider.
Volatility has once again been reaching levels experienced during market shocks we’ve seen in the past. The VIX (volatility index) in August reached levels seen during the Global Financial Crisis. However, the difference between the GFC and the current sovereign debt crisis is that whole countries have balance sheets with too much debt rather than individual companies being in trouble.
In fact, corporate balance sheets are looking healthier than they have in a decade. So with corporate balance sheets looking strong, convertible corporate notes may be a safe area in which to invest.
There are two main types of interest rate securities — corporate bonds, which are like loans, and hybrid securities, which are like investments.
An interest rate security is essentially an IOU. Companies issue these to raise capital. For investors, it can represent an opportunity for higher yield compared with term deposit products.
Demand for hybrid securities like convertible notes seems to be soaring. For example, recently ANZ raised the size of its ‘convertible preference share’ offer, CPS3, to $1.25 billion due to high demand. Originally, the bank was attempting to raise $750 million.
The ANZ CPS3 is offering a margin of 3.1% above the bank bill swap rate. That would represent a yield of around 7.73%.
During times of volatility, targeting high and stable dividends is considered a conservative, defensive strategy. After all, dividends are paid out regardless of whether the market is moving up or down.
Convertible notes have debt as well as equity characteristics. It is like a fixed interest security with an option to convert into shares at any time before the maturity date. There are usually franking credits associated with dividend payments which can make this type of investment a tax effective one.
But remember, one lesson we learned from the GFC is that convertible notes can have greater volatility compared with more traditional fixed interest products. The price of the convertible note usually moves in the same direction as the stock. That means if the stock price moves down, then the convertible note will usually move down in price as well.
They are safer than equity but riskier than debt. Investors still need to evaluate risk, which will depend on:
> the underlying financial stability of the business
> the company’s ability to service its debt
> interest rate movements
> the underlying stock performance
> the time-frame for the investment.
The big banks have hybrid securities. The ones below all have mandatory conversion. This means that the note must convert to the underlying stock on or before the maturity reset.
ASX Code
Margin over
BBSW
Face value
Price
30 Aug 11
Maturity reset
ANZPA
3.10%
$100
$100.60
Jun 2014
ANZPB
2.50%
$98.85
Dec 2016
ANZPC
n/a
Sept 2019
CBAPA
3.40%
$200
$206.00
Oct 2014
CBAPB
1.05%
$196.00
Oct 2012
WBCPA
2.40%
$100.25
Sep 2013
WBCPB
3.80%
$105.40
Sept 2014
Some things you should be aware of before buying hybrid securities are:
> face value
> current yield
> gross yield to maturity
> price
> maturity reset and
> conditions on the security.
You can find more information on the ASX website.
You can also find a list of hybrid securities/convertible notes on the Bell Direct website under Quotes & news/Interest rate securities and then choose ‘Convertible notes’ from the drop-down menu.
Happy investing!
Julia Lee
Equities Analyst
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