How to get high yields with bonds

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Bonds can help you lock in a good long-term return. Photo: Louise Kennerley

How to get high yields with listed investment companies

Local investors with excessive cash in portfolios will suffer if banks cut term-deposit rates and improving Australian economic growth nudges inflation higher. Already, high-income earners receive close to nothing on term deposits after inflation and tax.

Unless investors can hold shares for long periods and withstand paper capital losses, a better strategy may be searching for quality investments that offer higher yields than cash. Corporate and government bonds are one such investment.

Unlisted corporate bonds

Suit more conservative investors seeking higher yield with less risk than shares.

The sharemarket downturn has forced more investors to revisit unlisted and listed corporate bonds in Australia and overseas, and government bonds, to maximise yield and lower risk.

The preference of FIIG Securities Australia director of fixed-income research, Brad Newcombe, is for unlisted, tier one corporate bonds from blue-chip issuers.

“Investors in this market should look for securities that offer equity-like returns with bond-like risk,” says Newcombe.

Wholesale corporate bonds that have a $500,000 face value can be hard for retail investors to access; FIIG’s DirectBonds service lets retail investors access wholesale bonds in $50,000 and $100,000 parcels.

Combining government and corporate bonds

Suits more conservative investors seeking higher yield with less risk than shares. More risk here than buying straight fixed interest.

Australian government bonds offer security and liquidity, and yield about a low 4 per cent. The NSW government has launched Waratah bonds to fund state infrastructure projects. Offering an annual 4.25 per cent yield for the three-year bonds, lower than many bank accounts, Waratah bonds received a lacklustre response from fixed-income experts.

Evans & Partners’ Mike Saba, a top-rated fixed-income and derivatives strategist, says conservative investors should have a 20 to 30 per cent weighting to Australian government or semi-government bonds in their portfolio’s fixed-interest component, with the rest spread across unlisted and listed bonds and hybrids to boost overall yield.

“Government bonds provide security and liquidity, and their fixed rates are important if interest rates fall,” Saba says. “However, investors may have a higher yield target, hence including higher-yielding quality, shorter-dated interest rate securities will boost the overall return and keep the risk profile low.”

Some issuers provide an extra 1 per cent to 2.5 per cent annual yield on the hybrid if they choose not to redeem the security for its face value or exchange it for ordinary shares after a certain period, hence the term “step up”.

For example, for ASX hybrids, Saba at one point in 2011 favoured the short-dated mandatory CPS (CBAPB) for a 13-month yield to maturity of 8.20 per cent, including franking credits. For longer-term investors, Saba favoured stepped-up hybrids from Commonwealth Bank (PCAPA) and Westpac (WCTPA).

At the time, he explained his reasoning as follows: “These hybrids have been left behind in recent months, and offer a yield to maturity of about 8.4 per cent to 8.6 per cent, which is more attractive than most mandatory converting preference shares, which are offering around 7.4 per cent. I believe it is unlikely that the step-up in these two bank hybrids will occur, and that there is high probability of redemption at the step-up date.”

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