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.
|
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.
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