A strong year for retail bonds

Transcription

1 A strong year for retail bonds The Orderbook for Retail Bonds (ORB) opened 1 February 2010, with the aim of promoting both a transparent secondary market in bonds for retail investors as well as developing a primary market to distribute dedicated retail bonds to investors. At launch a range of existing bonds available to trade in smaller denominations were quoted on ORB. Since the start about 30 dedicated retail issues have been launched raising over 2.3bn* with the second half of 2012 being particularly busy from a new issue perspective. We use the end of the year as an opportunity to look at how the retail bond market has become more established and review some of the bond performances. Retail Bond Issuance (number of new issues, excluding some structured tured bonds) Source: Investec The retail bond market allows issuers to diversify their funding base which has been especially important at a time when banks are reducing balance sheets. It also gives retail investors a better opportunity to invest directly in bonds with the associated fixed income stream and fixed maturity date. Investments in fixed income funds may give investors access to the lower risk profile of bonds (compared to equity investments, and subject to fund leverage and investment profile) but funds do not provide the same certain cashflow, and of course the retail bond market gives investors direct control over which credits to invest in has seen a sharp increase in retail bond issuance. Market turbulence affected first half issuance and only 3 of the 14 sterling denominated bonds launched this year came in the first half. The second half has seen over 1.1bn raised in the retail bond market, roughly the same amount as in the preceding 18 months put together*. With the market continuing to grow we could well see new issuance trying to break the 3bn mark in (* We have excluded the EIB 3.25% 2016 bond from our calculations, while an ORB listed bond this issue was largely taken up by institutional investors, so including it exaggerates the amount raised from retail investors. Other issues will also have seen some institutional involvement, but to a much smaller extent than for the EIB issue.)

2 We thought it would be interesting to look at how this new market has performed since launch and whether it serves its purpose in providing a transparent secondary market for retail investors. The growth of the market as mentioned above does to a large extent provide an affirmative answer to the question of whether it is serving its purpose in developing a primary market for retail bonds. More market makers, improved transparency Let s look at the transparency issue first. In the early days of ORB most issues had only 1-2 official market makers, banks or brokers committed to make two way prices on the exchange, though a small number of others may have made prices on their own trading platforms. Over the last year this has improved and most of the dedicated retail bonds now have at least 5 official market makers. A larger number of price providers ensure greater price discovery and transparency for investors and it also signals that the retail bond market is becoming more established. Going forward we expect to see this trend continue, though there will always be some difference in liquidity between smaller and larger issue sizes. There may also be potential for a stronger overlap between institutional and retail markets in the future which could improve liquidity for the retail market, though it will be important to ensure that this enhances rather than crowds out the retail market. Performance of retail bonds, absolute and relative With bond yields trending down over the last few years and reaching historic lows in 2012, absolute performance of most bond issuance has been good and total returns have mostly exceeded yields at issue as can be seen by all but two of the fixed rate issues trading above par value (issue price). Low yield levels have driven a hunt for yield across bond markets and the retail market has not been immune to this saw mainly rated investment grade companies accessing the retail market, the exception being Tesco Personal Finance, which does not have its own rating. In 2012 there have been 7 unrated deals to date, mostly by FTSE 250 companies. Retail investors may be familiar and comfortable with these issuers, but it is fair to say this represents a move into higher risk and therefore higher yield territory compared to deals brought to market in Higher risk could leave retail bond holders more exposed in case of a deteriorating economic environment, but it has provided a good return to date and with our core outlook forecasting a gradual if somewhat slow improvement of the economy, the general prospects should look good for the year to come too. Relative returns have also generally been good for retail bonds, though the picture gets a little more mixed here. Of the dedicated fixed rate retail bonds issued since the launch of ORB back in 2010, 6 of the 17 bonds currently trade at a spread over gilts wider than that at issuance. (We have used spread as of first settlement day with the corporate bond valued at par as issue spread, retail bonds are not issued on a spread over gilt basis and the long subscription period makes it difficult to give an accurate issue spread ). Because of the higher yield at issuance only 4 of the 17 bonds have underperformed gilts of a similar maturity since the launch of the relevant retail bond. The table below shows the percentage total return outperformance of individual issues relative to gilts. The first bond issued, the Provident Financial 7% 2020 has returned 26.85% to holders who bought when it was issued in April 2010, that return comprises the 7% annual coupon (paid semi-annually) as well as the price gain as the bond currently trades at The 2.77% underperformance shown in the table below is a result of the 4.75% 2020 gilt having returned 29.6% over the same time period. The bonds are listed in order of issue date, St Modwen is the most recent issue (Unite is the last confirmed issue, but has not yet reached first settlement date) and as mentioned Provident Financial 7% 2020 was the first dedicated ORB issue. As the TR returns below are not annualized older issues benefit from having had a longer time to accumulate yields above those of gilts. For example the best performer on the list, Intermediate Capital Group 7% 2018 has outperformed gilts by 9.57%, roughly half of that comes from the spread tightening, and half from the issue yield. St Modwen 6.25% 2019 was issued about a

3 month ago and nearly all the return to date comes from spread tightening, higher price with the bond having had very little time to accumulate return from the issue yield. Retail Bond Total Return relative to relevant gilt, % since issuance (not annualized) St Modwen 6.25% 2019 London Stock Exchange 4.75% 2021 Workspace 6% 2019 Beazley 5.375% Intermediate Capital Group 6.25% CLS Holdings5.5% ICAP 5.5% Primary Health Properties 5.375% Tesco Personal Finance 5% 2020 Provident Financial 7% Intermediate Capital Group 7% Places for People 5% 2016 Provident Financial 7.5% 2016 Lloyds TSB Bank 5.5% EIB 3.25% Tesco Personal Finance 5.2% Provident Financial7% Source: Bloomberg, Investec

4 New Issue Premiums While many investors in retail bonds are buy-to-hold investors there is always some selling of old issues as new ones are announced. We thought it would be interesting to see how a strategy of selling one s holdings to invest in the next issue would have fared in the retail bond market, this should also give us some indication of the degree of new issue spread available in the market. If an investor bought 100,000 of Provident Financial s 7% 2020 note, the first ORB issue (we are ignoring the RBS issues, though dedicated ORB issues most are more akin to structured notes), sold it when the TSCOLN 5.2% 2018 came along nearly a year later and then kept trading out of issues as new fixed rate bonds came along, the portfolio would have grown to about 163,200 over the 20 month period, or an annualized return of nearly 35% (we have assumed coupons or accrued are reinvested when buying a new bond, but ignored interest on interest as it only applies to the first Provident Financial issue, under this trading strategy all other bonds would have been sold prior to first coupon date). Some of this performance is due to generally lower yield levels, while a general widening of spreads would have worked to drive returns down, so how much is due to the new issue spread? If you bought the 3.75% 2019 gilt in April 2010 and held on to it, you would have seen a return of about 29.5%. The iboxx non-gilt 5-10year index saw spreads against benchmark widen about 40bps in the period from April 2010 to date, a 40bps widening would take about 3% off a 7 year bond. Taking the two effects together we can estimate the new issue premium effect to have added about 35% to the performance, or about 2.2% per issue (we have looked at 17 bonds, so 16 switches). Return from new issue trading strategy % Initial investment % 100 PFGLN 7% TSCOLN 5.2% EIB 3.25% LLOYDS 5.5% PFGLN 7.5% NBHA 5% ICPLN 7% PFGLN 7% TSCOLN 5% PHPLN 5.375% IAPLN 5.5% CLILN 5.5% ICPLN 6.25% BEZLN 5.375% WKPLN 6% LSELN 4.75% SMPLN /12/ /11/ /11/ /10/ /09/ /09/ /09/ /07/ /07/ /05/ /04/ /12/ /06/ /03/ /03/ /03/ /02/ /04/2010 Source: Bloomberg, Investec

5 A couple of warnings, the above analysis is simplistic. It assumes all bonds issues are suitable for a portfolio. This could well be the case, but in real life investors may set restrictions on investing in for example non-rated bonds, or limits on how much can be held in any one issue. The issuer space is also relatively small and because there may be some self-selection on the part of issuers, with the new market place attracting issuers keen to attract new investor bases the premiums paid may have been higher than what can be expected over the longer term as the market becomes more established. And, as always, past performance is not a guide to the future. The Year Ahead We expect the retail bond market to remain active in the next year and judging by issuance volumes in the second half of 2012 the prospects look good. The market is likely to continue to move with the economic environment. A stronger economic backdrop may increase demand for inflation indexed bonds, the inflation indexed retail bonds have not seen the same strong performance as conventional bonds to date, but a clarification of the RPI question and potentially wider concern over inflation could change this. Investor concern over the general level of interest rates may perhaps bring floating rate issuance. Or if things take a turn for the worse retail investors may rediscover their appetite for high quality, safe credits. Whichever way it goes we expect the market is here to stay, serving both investors and issuers alike.

6 Appendix Issue Spread (bps) Current Spread (bps) Gilt TR over same period % Current TR from Issue Bond Issue Date Price issuance % Size m PFGLN 7% /04/ TSCOLN 5.2% /02/ EIB 3.25% /03/ LLOYDS 5.5% /03/ PFGLN 7.5% /03/ NBHA 5% /06/ NGGLN 1.25% 2021 IL 06/10/ TSCOLN 1% 2019 IL 16/12/ ICPLN 7% /12/ NBHA 1% 2022 IL 31/01/ PFGLN 7% /04/ HSBC 2.875% /04/ RMB 2bn TSCOLN 5% /05/ SVTLN 1.3% 2022 IL 11/07/ PHPLN 5.375% /07/ IAPLN 5.5% /07/ CLILN 5.5% /09/ ICPLN 6.25% /09/ BEZLN 5.375% /09/ WKPLN 6% /10/ LSELN 4.75% /11/ SMPLN /11/ UNITE 6.125% 2020* 12/12/ Tullett 5.25% 2019* 11/12/2012 Alpha Plus 5.75% 2019* 18/12/2012 Source: Bloomberg, Investec. * bonds not yet formally issued, TR= Total Return A note on Issue Spreads: We have defined issue spread to be the spread over Gilts on Issue Date with the bond valued at Issue Price (= par for retail bonds). Because retail bonds are issued at par and there is a long subscription period the spread over Gilts may vary (in some cases substantially) between announcement and issue date. Contact Details Elisabeth Afseth Fixed Income Analyst Brian Barry Fixed Income Analyst

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