An income investors secret weapon in 2023: Exploring public and private markets

Drawn by appealing yields and the perpetual necessity for portfolio diversification and resilience, investors are gravitating towards this asset class. However, understanding the dichotomy of public versus private fixed-income assets is pivotal. This article unravels the benefits of each, outlining their significance in contemporary portfolios.

Navigating The Public Bond Market

Australia is home to many higher-quality fixed-income managers and, as the fourth largest savings pool globally, there are numerous global funds with an Australian presence. Public fixed-income assets include Government Bonds (Commonwealth, State or Quasi Government), Corporate Bonds (issued by better known companies) and Asset-Backed Securities (typically issued by bank and non-bank financial institutions). Being public in nature provides investors with an element of liquidity in that there typically is a market to buy and sell such assets however the amount of liquidity is primarily determined by how large that bond issue is, how well known the issuer is and the complexity of the security. For example, an Australian Commonwealth Government Bond has substantial liquidity. In this regard, investors can, to varying degrees, buy and sell those bonds directly or via a broker. They can also access such assets via a Fund that can provide liquidity by allowing them to apply and redeem in accordance with the Fund terms. Public bonds benefit from relatively standard upfront disclosure when they are first issued so investors can more readily compare one issuance/bond to another.

In most cases, the issuer or the individual bond will have a credit rating so investors can have greater confidence that bonds attracting this credit rating fit their risk appetite (e.g. an investor may have risk appetite only for bonds rated AA or higher). Large and more commonly used Credit Rating Agencies (e.g. S&P, Moody’s) are global, so one can also more readily compare an Australian bond to a UK-issued bond. The public bond market in Australia is large at over $2 trillion and plays an essential role in institutional and individual portfolios.

Private Assets: Unlocking Liquidity & Assessing Risk

Private fixed income assets are primarily Corporate and Asset-Backed Securities and can be issued by the same entities that issue public bonds. Unlike public equivalents, private fixed income assets can vary significantly in nature and do not commonly have a credit rating attached to them. They often arise through direct engagement with the issuer where bespoke terms are negotiated between one or just a few parties rather than being more widely held by many investors in the market. Those investors value the direct relationship with the issuer and, importantly, the enhanced terms that can be achieved. For example, private equivalents can include security over assets in addition to a corporate guarantee where any non-payment could enable the investor to pursue the company directly. Any enforcement actions required could also occur via direct engagement with the issuer, whereas public equivalents often require many parties to engage, determine the best approach, vote and then act via a representative thus, it can be more drawn out, costly and less predictable.

Private fixed income assets however are not, by themselves, particularly liquid. They typically have a maturity where capital is scheduled to be returned however, before then, there can be limited ways to sell them. While this is true if you hold just one bond, buying a second bond that matures between now and the maturity of the first bond, doubles the liquidity frequency. Buying a further bond at a different maturity adds further liquidity, and so on. If you have a $100m+ portfolio, strategically planning scheduled maturities can add significant liquidity. If you don’t have that quantum, a fund specialising in such investments can provide added liquidity.

Another consideration with private fixed-income assets is that a rating agency may not rate them. If you buy one of these assets directly, you must assess the asset’s risk profile and suitability for one’s portfolio. Please read my prior article here for thoughts on this. Assessing suitability involves considerable domain expertise in that sector gathered over market cycles, access and time to evaluate the opportunity through direct engagement with the issuer and both qualitative and quantitative approaches to understand the risks and assess the appropriateness of the mitigants in place. While there are no official numbers, our estimates of private fixed-income assets exceeds $200 billion in Australia alone.

Accessing Opportunities: The Dual Role in Investor Portfolios

Investing in private fixed-income assets is more complex, time-consuming and requires additional scale to achieve a degree of liquidity. In our experience, investors can typically receive 2-3% more per annum (than equivalent public assets) to compensate them for that impost. For example, we recently purchased an asset for the Fund, which, notably, met our threshold question: will this asset perform through the economic cycle and delivers a running yield of 11.50% per annum.

We see both sectors playing an essential role in investor portfolios, although we are drawn to the higher risk-adjusted returns that private fixed-income markets offer where we have the scale, domain expertise and time to extract them for our clients.

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