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Market News 21 September 2020

No election views from me.

I promise.

INVESTMENT OPINION

Duration – 30-year bonds have finally arrived in New Zealand, which is excellent news for the maturity of our market.

One might have guessed the NZ government to be the first issuer of 30-year bonds, but no, Auckland Council has led the way offering a bond with a fixed rate of 2.95%.

Up until this point I would have expected all but the ACC and Guardians for NZ Superannuation Fund to be scared off by the 30 year term but, au contraire, the demand was so large and so fast to present itself that Auckland Council closed the offer early.

The plan was to open last Monday and close on Friday, but the deal was closed on the Wednesday afternoon.

I can think of two opposing perspectives here:

Auckland Council and the lead managers of the deal will be very pleased about the result; but,

Some investors will feel they missed out on the opportunity as a result of the immediate and unexpected change to the timeline for the offer.

I can sympathise with both opinions.

Once you decide that you wish to borrow a large sum of money you just want the deal done.

If you are an investor you want to understand the details and have some time to assess the opportunity as it relates to your portfolio. Most would, and should, seek financial advice. All of this typically takes days, not hours.

Did Auckland Council mislead the market with the offer?

A little. Especially for retail investors, which add breadth to a register, but legally, no, they did what it said on the tin.

Retail investors have only recently settled in to understand why bond offers changed from being four weeks long to only four days (fast moving, often booked by contract note) yet last week they were told to understand the fine print, which said:

Council may allocate Green Bonds (including oversubscriptions) to those persons during the offer period or once the offer closes at Council's discretion.

Yes, I confess, I made that script intentionally finer.

The Financial Markets Conduct Act enabled these fast moving deals under its same class as existing quoted debt securities category, which has been a very useful flexibility option for capital markets.

Historically I thought four weeks was a good time frame for these offers, but on reflection I think at least two of the weeks were wasted and we have been proving that one week is plenty.

Is two days plenty?

No. It is not.

Retail investors are an important part of the market, and thus the funding options for all capital markets users, so shutting some out simply through extremely short time lines is unhelpful.

I will counter my own argument a little though by saying that clients receiving financial advice found it much easier to enquire and conclude whether or not they should participate in such an offer and as a result these folk were very well positioned to participate in the Auckland Council bond offer.

Retail investors are important players, but in my unquestionably biased view those investors gain advantage by seeking financial advice during their investment process. (*see Post Script)

Auckland Council has reminded investors that timeliness is important with decision making. I'll remind investors that access to financial advice, and operating to an investment strategy, makes decision making easier; if its easier decisions can be made faster.

Prompt responses were rewarded in this offer, and will be in most offers.

An investor on Monday last week who knew they had a need to add to a fixed interest sub section of the portfolio, and/or to add to the duration (average life) of that fixed interest portfolio, would then only need financial advice specific to the bond on offer for its suitability.

Default Risk – Auckland Council. Debts serviced by the rating base of the council (unquestionably reliable);

Terms of the loan – Very simple, fixed term, fixed rate. Senior debt without complex terms or conditions;

Maturity Date – 30 years (*more below);

Liquidity – Excellent. All investors and the Reserve Bank currently consider including council bonds in their portfolios.

Yield – 2.95% (*more below)

The discussion between an investor and financial advisor will then have focused on the 30 year term and the defined reward.

A good financial advisor should quickly have been able to explain how the 2.95% reward was fair, based on a variety of relativities.

This leaves the debate focused on the 30-year term. This is the driver of the volatility (another risk) within the investor's portfolio. The market pricing of a 30-year bond has far more volatility than the pricing of a 1-year bond.

Think of the 1 and the 30 as being the length of string on two pendulums.

Typically we invest in fixed interest assets for their price stability to offset the higher volatility carried in property and shares asset types. So does a 30-year bond add volatility, or stability, or both?

Even after you accept this additional volatility, making a 30-year investment decision turns your head upside down because almost everyone starts to align it with their life's runway and quickly become short sighted.

I understand, but it's not the right way to decide whether or not to include such a bond in a portfolio. A fixed interest portfolio still requires diversity across borrowers and across time, without limiting that time range.

To try and limit the time range of your fixed interest portfolio is to take a strong, or very strong, view about the future direction of interest rates.

If one dislikes the notion of a 30-year bond now, I'd wager that the same person would have disliked 30-year bonds 10 years ago when yields were much higher.

People who invested in 30-year bonds in 2010, and kept them, have very broad smiles on their faces today and have slowed the decline in the incomes they receive and are sitting on escalated bond values should they need to sell an asset to raise money.

Is the falling interest rates gig up?

Is 2.95% unreasonably low?

I simply don't know, but the market just agreed to lend Auckland Council $500 million over 48 hours based on those terms so the collective view today is that 2.95% for 30 years is OK.

That being the case, there is a loud message that investors need to digest that the investment community, which is very wide and deeply ingrained with skill, thinks interest rates will remain low for a very long time indeed.

You can see the ramifications of this view showing up in all other asset classes too.

I have two hopes as a result of this successful Auckland Council 30-year bond offer:

More councils will copy them and provide more such bonds to investors; and

More of the public will engage with the financial advice community (hopefully you – Ed).

*Post Script – Two days after the close of the Auckland Council bond offer we saw an email from another broker / advisor offering these new AKC130 bonds at a secondary market yield of 2.35% supported by a tension building recommendation to act quickly.

A 0.60% yield movement on a 30-year bond equates to a new purchase price of $112.86 per $100 of bonds.

In my opinion having the new bond owner and this broker claim a 12% gain in 24 hours should stretch the minds of the integrity unit at the FMA, if the person who wrote their recent FMA bond tutorial document truly understands the bond market.

If this development is OK, then there is something dysfunctional about the way our bond market operates (illiquid) and rewards participants (excessively).

Heartland Group (HGH) – Announced a good profit result in the face of elevated loan loss risks from Covid19 and announced an unexpected surprise by declaring a dividend to shareholders.

Heartland Group enjoyed sufficient income from its Australian operations to deliver the dividend. Heartland Bank (part of the group) will have retained its profits, not passing a dividend to the group, as requested by the NZ central bank.

HGH also announced a new funding programme in Australia to support its expanding Home Equity Release business activity there.

We will take a closer look at the result and Kevin Gloag may update our research article on the private page shortly, to factor in the latest news.

Paper Money – Regulators want use of paper money to decline, mostly to improve monitoring but now also because of its role in the Covid19 contagion.

You’d have thought the public would be on board with the second reason, but central banks are in the midst of ordering the production of more paper money than usual, right now.

In a related article an analyst presented a chart of data that was also counter-intuitive; during periods of increased paper money in circulation, inflation falls.

Strange but true (according to that data – Ed).

GDP – The large negative GDP data released last week for the second quarter (March – June) was of no surprise to anyone. However, GDP predictions have become more volatile than financial markets, which is saying something.

I remind you of the excellent GDP live service. I hope Massey University has found a sponsor and won't close the facility. I still don't understand why Treasury doesn't fund it.

http://gdplive.net/Dashboard

GDP Live seems to be witnessing a rapid lift in GDP for the September quarter, hopefully bringing year to date GDP back 'up' to only -1.25%, a period including Auckland's second lockdown.

A return to a neutral, or a small positive annual change for GDP by the December quarter, seems to be a credible expectation.

Now, more importantly, we need to resolve how the country will complete next year's harvest in the horticulture sector and avoid an unnecessary pot hole (a new economic term? – Ed).

 

Proxy Voting – It's voting time again on many of your shares.

As interested as I am in many of the items even I tire a little of participating in exercising my votes.

This makes it even more important that (if you haven't already done so) you appoint the NZ Shareholders Association as your Standing Proxy.

Then, they represent you and your vote at all future meetings when you are invited to vote.

There are forms to use when appointing a Standing Proxy.

We have those forms, plus populated examples; please ask us for them and we'll be pleased to email them to you.

You complete the forms and send one to Computershare and the other to Link Market Services.

Whilst a Standing Proxy is in place you retain your right to vote. If you elect to vote on an issue your action trumps that of the Proxy, however, I'd suggest that the reason for appointing a Standing Proxy is so that you no longer have to consider the minutiae being addressed at the meetings.

The ultimate way of thanking the NZ Shareholders Association for their efforts made on your behalf is to become a member and pay their subscription (modest).

You do not need to be a member to appoint the NZSA as a proxy but it is a nice thing to do.

EVER THE OPTIMIST

EROAD continues its international expansion and is a business 'NZ' should be proud of.

We need more such businesses, and to have them widely available to investors. So many companies are removed from our access through the process of takeover (witness Metlifecare currently) without replacement businesses being added to the market often enough.

I see plenty of start-ups via the venture capital environment but at this stage very few of them make it to NZX listing. Most strive to sell the entire business to others, once established.

It was nice to read that ERD is the opposite; it is being approached by companies asking EROAD to buy them.

ERD will now be listed on the Australian Stock Exchange (ASX) simultaneously with the NZX.

It has taken advantage of the recent increase in the ERD share price, that better reflects the business's evolving success, and raised $50 million new capital to both bring new Australian shareholders onto the register and to fund the accelerated development of the business.

If you happen to be an ERD shareholder we encourage you to read the company's presentation updating the market on the current situation and I'd suggest dwelling on the page 06 slide to enjoy what ongoing sales growth looks like. It's a nice chart.

Investment Opportunities

AKC130 bond– Auckland Council completed the issuance of $500 million 30 year bonds at 2.95%. It was a very successful transaction and we hope other councils will follow their lead.

For my amusement, I like the NZX ticker code for this new bond – AKC130 – being the 1st bond issued for a 30 year term in NZ.

Thank you to all who participated in this bond offer through Chris Lee & Partners.

Port of Tauranga – Is having a presentation of recent company performance and 'may' follow this with the issuance of a 5-year senior bond.

However, the bond offer is targeting institutional investors ($500,000 minimum).

Armed with an ''A-'' credit rating the market is likely to lend POT money at about 1.10% which should, if nothing else, please shareholders of POT (current dividend over the past year is an implied 2.35%).

Debt costs for strong business are quickly becoming statistically irrelevant relative to other business risks.

TRAVEL

David Colman will be in Lower Hutt on 7 October.

Johnny will be in Christchurch on 7 October.

We have now planned our final four seminars.

Timaru – September 24 – 1:30 pm - Sopheze, Caroline Bay

Tauranga – September 29 – 11:30am - Tauranga Yacht Club

Auckland – October 5 – 11:00am - Mt Richmond Conference Centre

North Shore – October 6 – 11am - Fairways Event Centre, Takapuna

Chris will be able to meet individually with clients after each meeting.

Those who have not confirmed their attendance would help us immensely by confirming their plans now.

Thank you to the 1,100 people who have attended seminars in Kapiti, Wellington, Christchurch, Nelson, Palmerston North and Napier.

The seminars are entitled ''No Hiding From Risk''.

Please let us know now if you would like an appointment in your town.

 

Thank you.

Mike Warrington

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