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Macquarie looks for diversity with Commodity Bonds

8.2%pa, a global fund manager managing capital risk and a Standard & Poor’s credit rating makes an attractive combination. But in the current environment of nervousness around the riskier end of the market in New Zealand, and with the lack of rated alternatives, Commodity Bonds have quickly gained a lot of appeal with institutional and retail investors.

Tuesday, August 1st 2006, 10:57AM

8.2%pa, a global fund manager managing capital risk and a Standard & Poor’s credit ratingi makes an attractive combination. But in the current environment of nervousness around the riskier end of the market in New Zealand, and with the lack of rated alternatives, Commodity Bondsii have quickly gained a lot of appeal with institutional and retail investors.

What are Commodity Bonds? Commodity Bonds offer a 5 year fixed income stream of at least 8.2%pa, paid quarterly. They are expected to be issued with a credit rating within Investment Grade that historically has related to a 99.5% probability of full capital and income payments being metiii.

But this strong yield and credit rating are not the main attraction for these investors. Its diversification - that is the big story for New Zealand investors, particularly those concerned about recent finance company defaults and stories of investors that were insufficiently diversified to avoid having major lifestyle impacts from these defaults.

Is diversification really that difficult? With all the choices available: capital notes; property trusts; investment property; finance debentures; Kiwi Bonds, its easy to diversify, isn’t it?

However, what if there was a shock to the New Zealand economy? While highly unlikely, imagine the effect of a shock to the economy that would be caused by, say for example, a foot and mouth breakout in New Zealand.

Such an outbreak would have consequences for every part of the economy, and therefore would impact all New Zealand fixed interest investments listed above. A portfolio spread across multiple New Zealand based investments may not be as diversified as it may appear at first glance.

The key questions to ask when designing a fixed income portfolio for your clients are: “What is it that provides the cashflow used to pay my interest costs on each of my investments?”; and “Are there any single event risks that could impact all of these cashflows at once?”.

Commodity Bonds derive their cashflow by taking commodity price risk on the principal, in much the same way that a dairy company’s capital notes pay interest in return for investors taking dairy price risk, or a retail company’s capital notes pay interest in return for investors taking risk on the level of retail spending. But these commodities are not linked to the New Zealand economy eg the price of Gold would not fall if there were a recession in New Zealand.

Some key points to note about Commodity Bonds and their link to commodity prices:

1. Commodity Bonds do not require prices to rise to be able to pay 8.2% pa
2. If prices fall to long-term averagesiv over the next five years, there is no impact on the return to Commodity Bond investors. That is why they are able to be rated Investment Grade by Standard & Poor’s – corporate issuers with the same credit rating experienced a 5 year default rate of around 0.5%, or 1 in 200iii.
3. Having a manager is intended to assist in protecting against a loss of principal on the Commodity Bonds. The manager will have the ability to make changes to the underlying reference portfolio of commodities in order to attempt to preserve the principal at the end of the 5-year term.

Price falls below long-term averagesiv over a 10 day period near the end of the 5 year term may affect the return of principal as set out in section 3 of the Offer Document.

Profit from commodities even if prices don’t rise
Commodities and falls required before any potential impact on the principal of Commodity Bonds*. This illustration is based on the portfolio as at 10 July 2006. The only commodity from the energy sector currently included in the portfolio is Natural Gas.

* As at 10 July 2006 the Protection Amount protects the principal of the Commodity Bonds from the first 7 Portfolio Events. One subsequent event will reduce this principal to zero. A Portfolio Event occurs when the price of a commodity over a 10 day averaging period near the end of the 5 year term is below the relevant trigger level.
Current price – Commodity reference price as at 10 July 2006.
First trigger level – The highest trigger price for the relevant commodity in the Reference Portfolio.
Lowest inflation adjusted historic price – in 31 August 2011 constant USD terms, using monthly data from 31 January 1945 to 31 March 2006, assuming an inflation rate of 2.4% pa from 31 March 2006 to 31 August 2011.
Past performance of commodity prices is not necessarily indicative of their future performance.


At a time that many investors are concerned about some of the riskier investments in their portfolios, but still need certainty around the level of income they will receive, Commodity Bonds offer a real alternative.


iA credit rating is not a recommendation to buy, hold or sell the securities; nor does it attest to the suitability of an investment in the securities by any individual investor. Any rating is subject to revision, suspension or withdrawal at any time by Standard & Poor’s. An application has been made to Standard & Poor’s for a rating of the Commodity Bonds.
iiCommodity Bonds are issued by Generator Bonds Limited (“GBL”) in its capacity as trustee of the Commodity Bonds Trust (“the Issuer”) and constitute first ranking secured obligations of the Issuer. Applications can only be made on the application form attached to the combined prospectus and investment statement.
iiiThe methodology used to determine the credit rating of the Commodity Bonds is new and hence a track record of actual default rates is yet to be established. This information is based on the “S&P Research: Annual 2005 Global Corporate Default Study And Ratings Transitions”. As with any credit rating actual default rates may differ from expected default rates. Typically, upon a default of a corporate, creditors seek to recoup some or all of their principal amount from the issuer over a period of time, which may ultimately range from nil to full recovery. By contrast, in the case of the Commodity Bonds, a sufficient number of Portfolio Events may result in a sharp reduction or loss of principal on the Commodity Bonds and Bondholders will not be able to recover their loss from the Issuer.
ivThe long term average is calculated using monthly data from 31 August 1945 to 31 March 2006 in 31 August 2011 constant US$ terms, assuming an inflation rate of 2.4%pa from 31 March 2006 to 31 August 2011.

« Liontamer goes shopping for qualitySolid metal fixed interest alternative »

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