XTBs: The New Golden Age of Aussie Bond Investing?

A tremendous change is about to hit the Aussie bond market.

We’ve just discovered a great new way that you can buy bonds, starting on Monday.

Investors will soon catch wind of this new path to reliable income. When they do, we could see billions of dollars flow to this new market. The rush to get involved could make early investors rich.

We’ll show you how you can buy these bonds in a moment. First, let us explain what’s going on…

Your editor spent a closed-door session earlier this week with some of our key analysts and researchers. We got our heads together in support of the new advisory service we’re launching soon.

It will cater to yield-seeking investors. Our income specialist, Matt Hibbard, has years of experience doing just that. In today’s market, investors want compelling dividends and quick payouts. That makes now the perfect time to launch this offer.

We can’t give away everything discussed in the session. But you should know that some weird and wonderful ideas are bubbling up.

The group howled your editor down when he humbly suggested investigating Aussie corporate bonds.

Too complex! Too illiquid! Too dangerous!

Your editor took this as a cue to shut up. But it turns out we’re not the only one taking a shine to Aussie bonds. We’ll explain how you can benefit from that trend in a second.

But first, to understand this idea, you have to understand the difference between a bond and a stock…

You want to own bonds

A stock is ownership. When you buy a stock in a company, it entitles you to whatever dividends the business generates until you decide to sell the stock. Growth in profit and revenue is extremely important to you. Without that, your asset loses value and your investment declines.

A bond is not ownership. It’s a loan. You lend your money, receive regular interest, and after a certain time you get your money back. You have little interest in future profit or revenue growth with the party who takes your money. What matters most to you is the borrower’s ability to meet its short-term commitments…its solvency.

In general, when the economy is booming, you want to own stocks. Markets expand…businesses make larger profits…and return these to shareholders as nice big dividends.

Bonds, on the other hand, are generally less risky.

When the economy runs through a rough patch, companies usually cut their dividends. The fact that Australia’s biggest companies have boosted their dividends in the face of a flagging economy is a remarkable anomaly. It’s hard to see that as a sustainable trend.

But when companies do cut their dividends, they keep paying interest on their bonds. Share prices might fall, but bondholders still get their capital back in full, as long as the company doesn’t go bankrupt. What’s more, bonds tend to become more valuable in times of low inflation, or even deflation.

Our colleague Kris Sayce forecasts hyperinflation for Australia’s future…and he may well be right. But based on the here and now, inflation is low and looking lower.

In other words, when stocks look expensive, the economy looks patchy and price levels are falling…you want to own bonds.

But it has always been hard for private investors to buy Aussie corporate bonds. That’s simply because blue-chip firms in this country have never needed to sell too many of them here. Companies like Woolworths Ltd [ASX:WOW] and BHP Billiton Ltd [ASX:BHP] can access cheap and abundant funding through banks or the international capital markets.

Firms like these have had little incentive to encourage private investors to buy their bonds. That has left this market as the exclusive domain of institutional investors.

But a new player seeks to change that — starting on Monday…


A powerful combination

On Monday, the newly formed ‘Australian Corporate Bond Company’ (ACBC) will list 17 securities on the Australian Securities Exchange (ASX). ACBC will link these 17 securities to corporate bonds issued by blue-chip listed companies like Telstra Corporation Ltd [ASX:TLS] and Wesfarmers Ltd [ASX:WES].

ACBC calls these securities ‘XTBs’. That’s short for ‘exchanged-traded bond units’.

XTBs will let you buy a small exposure, of as little as a few hundred dollars, to the creditworthiness of the company of your choice. They will provide a regular and reliable income stream that, in most cases, will dwarf the return you might get on a term deposit or savings account.

It’s important to note that an XTB is a managed fund rather than a direct investment in the underlying bond. ACBC tacks on fees and expenses of around 0.4% of the upfront price of the security. That’s ACBC’s business model.

 Given today’s low interest rate environment, that fee will certainly influence the return you earn on this kind of investment…so make sure you factor it into your decision making.

It’s just as important to understand the coupon payment frequency, coupon percentage amounts, maturity date and yield to maturity on any XTB that interests you. All of that is available, along with the product disclosure statements, on ACBC’s website here. That’s where you can find a full list of the blue chip Aussie companies to which you can indirectly lend your money, and their ticker symbols.

This kind of investment is not risk-free. Depending on the underlying company’s capital structure, you might not get paid first in the event of a bankruptcy. What’s more, all of ACBC’s efforts will come to zip if investors don’t provide a liquid market for each XTB. These securities will have to trade in decent volume — of $100,000-worth per day, or more — to attract yield-hungry punters. After all, what’s the point of earning a few percentage points on a bond if you lose it all by selling it into an illiquid market?

ACBC has been around for less than two years. If the company eventually goes down the gurgler, there’s no telling what could happen to the securities it has brought into the world.

You might be wondering why a small-cap analyst like your editor would pump up large-cap debt investment. Well, XTBs might not offer the turbocharged potential profits of the kind of stocks we recommend in Australian Small-Cap Investigator…but when you think about potential reward per unit of risk, this path looks promising.

In spite of all the risks we’ve outlined above, it’s hard to not get excited about this prospect. Starting on Monday, investors like us will finally be able to lend money to some of Australia’s most creditworthy borrowers. And as investors come to realise that the regular income on offer here can potentially outstrip traditional sources — like term deposits, rental property and even dividend-paying stocks — the value of these bonds could rise considerably.

If you demand a steady income from your investments, you should closely consider XTBs when they start trading next week. As you’ll discover — solvency and liquidity can be a powerful combination.

Cheers,

Tim Dohrmann,
Editor, Money Morning

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