Income Asset Management: Here’s How to Play “Reopen Trade” in the Australian Corporate Bond Market
Particularly attractive returns are offered to investors who know where to look.
As post-COVID activity intensifies, investors are turning to sectors positioned to benefit from the “reopening” of trade.
While the upward opportunities for industries such as tourism are fairly clear, the market is still recalibrating the value for many companies that have felt the impact of COVID-19.
For Matthew Macreadie – director of credit strategy at Income Asset Management (ASX: INY) – it also creates unique opportunities for bond investors looking to build a risk-adjusted portfolio with attractive returns.
“I have put together research indicating that, like equity investors, bond investors should consider bonds in sectors that have been hit hard by the lockdowns,” Macreadie said.
“A number of bonds are trading relatively cheaply, and as the Australian economy normalizes, these bonds can provide good opportunities to generate alpha.”
Speaking to Stockhead recently, Macreadie offered information on four such investments – two in the High Yield (HY) space and two Quality Investment (IG) opportunities.
The reopening trade – investment grade bonds
In terms of investment grade debt opportunities, a company on Macreadie’s radar is Scentre Group (ASX: SCG) – owner of the assets of the National Mall developed by Westfield billionaire Frank Lowy.
“I think shopping malls are going to play a big role in how people and households reconnect after COVID,” Macreadie said.
“It’s a good place to meet, which will speed up food and trade activity, increasing consumer demand. This will result in higher commercial rents, especially as the restrictions are lifted. “
But because commercial real estate has faced such a disruption from the pandemic, Scentre’s USD-denominated hybrid notes are cheap with a yield of over 4%.
This is a good return for a blue chip Australian company issuing debt backed by a portfolio of high quality retail assets.
In this context, Scentre is a prime example of “super cheap” corporate debt negotiation compared to the industry standard, Macreadie said.
His other choice in the IG space is GPT Group (ASX: GPT), one of ASX’s largest diversified real estate owners.
“The key point to note with GPT is that I think the dynamics of working from home and the negative consequences of declining office occupancy levels have probably been overestimated,” Macreadie said.
“People are moving back to the city and businesses still have a lot of their rented space. So these lower (real estate) valuations didn’t quite perform as the market and many had expected. “
At the same time, GPT has just issued 10-year bonds for its new wholesale business at a healthy yield of 3.25%
“If you bundle these ideas together, you can get a 3-4% investment-grade blended return that should outperform over the next 6-12 months,” Macreadie said.
“Investors should look for opportunities in sectors that have underperformed and move away from sectors such as consumer staples and telecommunications companies which have performed very well during the pandemic.”
Reopening Trade – High Yield Bonds
Using the same strategy, Macreadie said there are great opportunities in the high-yield space as well – starting with Crown Resorts (ASX: CWN).
The ailing casino operator briefly faced the prospect of losing its national license, before being given a two-year window to resolve its regulatory issues under government watch.
“As restrictions are lifted in Sydney and Melbourne, we are seeing Crown venues fighting hard for the entertainment dollar,” Macreadie said.
Additionally, Crown has now cleared most of its regulatory hurdles while its main competitor, Star Entertainment, comes under increased scrutiny.
Given all of this, Crown’s hybrid notes are currently trading at a significant discount to their face value, and it is currently paying a coupon of 4% above the banknote swap rate.
Together, “the yield to maturity on these bonds is close to 10%, for a large company with a two-year grace period to sort out its regulatory issues,” Macreadie said.
“This yield figure looks very attractive, especially since Crown’s senior unsecured debt still has a BBB- rating and the company is well positioned for the reopening theme.”
Macreadie’s other pick in the high yield space is the troubled listed debt specialist Pioneer credit (ASX: PNC).
PNC’s basic business model is to buy portfolios of high-risk debt from large banks and collect overdue loans under the terms of payment agreements, then liquidate them.
During the pandemic, banks did not release these wallets in their efforts to provide goodwill to customers facing financial difficulties.
As a result, Pioneer’s business dried up.
“We believe PNC is in a good position to acquire these assets as soon as they start to hit the market,” Macreadie said.
“And as employment conditions improve, that will also lead to an increase in salvage values in these underlying portfolios.”
In the doldrums, Pioneer is an established company issuing high yield bonds that still pay a 9% return.
Macreadie added that until recently the company struggled to refinance its own operations at a reasonable rate.
“They went through that process and refinanced themselves at a lower rate, and now they’re also leveraged for the COVID-19 exit,” Macreadie said.
“We think the market has overlooked this, and this is the main reason why the yield to maturity of these bonds is so attractive.
Considering each of his four bond choices, Macreadie said it’s iconic for bond investors to build a balanced portfolio with attractive yields on IG and HY debt in the current market environment.
And this is happening where corporate debt can still offer a particularly attractive return, relative to government bonds.
While the RBA indicated earlier this week that its rate hike schedule will be brought forward from 2024, the lowest rates are more likely to stick around for the short to medium term.
“The aim is to look at sectors that are still poorly valued but which will benefit from reopening trade,” Macreadie said.
“This type of risk / return profile can complement the diversified portfolios of investors. Even if rates rise, they will most likely rise at a slower rate, so there are still plenty of good opportunities in this high yield environment. “
This article was developed in collaboration with Income Asset Management, an advertiser for Stockhead at the time of publication.
This article is not advice on financial products. You should consider getting independent advice before making any financial decisions.