Shifting Risk Preferences – Part 1

Cashwerkz, together with fixed income partner and specialist RIM Securities, thought to introduce and share with you their insights on fixed income.

In the first of our 2 part Blog series on this topic, we discuss market observations, easy-to-follow strategies, and general information for investors learning about fixed income to improve their investment performance.

Generally Fixed interest investors are a steady lot however looking at their aggregate investment portfolios since 2013 shows a few notable trends.

  • Though interest rates stayed in a similar range in 2015 and 2016 investors appear to be shying away from fixed coupons perhaps believing that the interest rate cycle has turned.
  • While small, there is a consistent trend in increasing credit exposure that shows up across the various metrics explored.

Using Bloomberg summary data we examined fixed interest holdings at year end for each of the last 4 years.  It is a rough look simply totalling up the number of holdings in each category.

Coupon Type

Bonds usually pay investors an interest rate that is fixed upfront or a rate that varies with bank rates.  The chart above also includes a third category of variable coupons not set by interest rates.  These variable coupon bonds are usually subordinated debt or some less common debt types.  From the graph you can see that in 2015 and 2016 investors have reduced the proportion of their fixed rate holdings.  The shift to floating rates is likely a straight forward concern that rates may rise.  The shift to variable coupons likely is a side effect of holding more subordinated debt as will be shown later.

Capital Structure Ranking

All debt obligations come with a ranking that determines which creditors get paid back first in the event the issuer becomes insolvent.  The most senior class is “secured” with specific assets identified to allow payment, the next is general senior debt without specific assets securing it – “senior unsecured” and the last in line to get paid are “subordinated” debt tranches.  As the chart above illustrates, in 2016 investors slightly reduced their holding of the safest secured debt while adding to holdings of subordinated debt.  This is probably yield seeking as low interest rates persist and subordinated debt pays higher rates.  It could also just reflect the increasing use of subordinated debt by banks due to changing regulatory capital requirements.

Credit Rating

This is the clearest indication of investors becoming more comfortable with risk.  The credit ratings are arranged with the least likely to default credit grades at the bottom of the chart.  The safest grade shrinks while it is the riskiest and highest yielding “below investment grade” bonds that benefit.  Reducing “AAA” holdings could be a side effect of avoiding government debt which usually has a fixed coupon and can be much longer in maturity (and therefore is much more sensitive to falling interest rates) but investors are clearly more comfortable with more credit risk in taking on the “below investment grade” debt.

In part 2 we will continue this analysis looking at investor holdings by issuer type, maturity, and country.

About RIM Securities

RIM Securities Limited is one of the best kept secrets in Australia and acts as the fixed interest engine for Australian investors by sourcing and executing fixed income securities. The business has established itself as a leader and key player in defensive assets placing in excess of AU$15 billion over the past 12 years. The firm is Brisbane-based and was established in 2004.  It is majority owned by Trustees Australia (“TAU”), which became listed on the ASX in 1987.

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