The Big Interview: Exchange Traded Bonds, bringing corporate bonds to Aussie retail investors

David Tuckwell

a man in a suit

The bonds of blue chip Australian companies, like BHP and the Commonwealth Bank, are attractive assets. They have higher interest rates than term deposits, but come with similar risk levels. The one problem: the corporate bond market is institutional, meaning retail investors struggle to get their hands on them, even when they want them. But Aussie corporate bonds are starting to become more available, thanks to Exchange Traded Bonds (XTBs), which trade on exchange intraday and hold their underlying assets in trusts - rather like ETFs. In this interview, ETF Stream talks to Richard Murphy, the CEO of XTB, the company bringing the bonds of Aussie blue chips to retail investors.

ETF Stream: Tell me about the corporate bond market in Australia and how you're changing it.

Richard Murphy: The bond market in Australia is 100% for institutional and sophisticated investors. There is a bond market where blue chip Aussie companies - like Woolworths, Telstra, Wesfarmers - can go to raise capital. But the bonds are not traded on exchange and are unavailable to most household investors. Companies have made it clear for 20 years to banks, exchanges and regulators that they aren't going to list their bonds.

But if bonds are not on exchanges then they don't get investment from retail. This is why we started XTBs.

How are XTBs structured?

They're not too different structurally to ETFs, basically, but each XTB is like an ETF of one bond from one company that will mature when the bond matures. In Australia, this structure is called a managed investment scheme, or a unit trust. Most ETFs and ETPs in Australia use that structure.

How is what you're doing different to what other companies offering corporate bonds to clients are doing?

There are other firms that bring corporate bonds to individual investors. But they work through the traditional institutional market and off public exchanges. They are banks or bank like groups that originate and distribute bonds to their own clients through their own distribution arms. Their clients hold the bonds themselves. But it also means they're limited to the large transaction sizes that occur in the bond market, and have to work with the custody and settlement system Austraclear, where the minimum transaction size is $500,000. Sometimes they can sell between clients within the one custody arrangement so they can deal in smaller amounts, but the minimum is still very high compared with ASX trade sizes.

You can buy XTBs however for around $100. With XTBs there is a lot more granularity and it's on public exchanges, so it's much more transparent. It also means that because the bonds are on public exchanges they also appear on all the major retail platforms. If you're not on an exchange or in a managed fund then you can't get onto the big platforms in Australia that distribute securities to all the financial planners in the market. The big platforms are major investment supermarkets basically, so XTBs find it much easier to be on these platforms by virtue of being listed. The other non-listed ways of accessing bonds is much clunkier for the end clients and none of the major platforms are connected to the custody and Austraclear world the wholesale bond market operates in.

We're effectively converting the wholesale clunky bond to a digital representation of the bond. All the major platforms are connected to CHESS, which is where everything including XTB is settled and held.

Why should ETF investors be interested in XTBs instead of fixed income ETFs?

Well, firstly, 80% of our sales are against cash and deposits, only 20% or so are against fixed income ETFs. But there is a fundamental difference between holding bonds and having them in a fund. Some of the key characteristics of bonds come from the fact they mature. This included their predictability, which is why investors compared bonds with predicable term deposits. You know on the day you invest in either bonds or TDs what you're going to get. You can predict accurately what you're going to get if you hold to maturity, subject only to the bond issuer not defaulting. In ETFs or any managed fund, which are perpetual vehicles, bonds are constantly replaced and as you can have 500 bonds in these funds, replacement is happening all the time.

By design an ETF or fund cannot tell you what income you're going to get over the next 4 years with any certainty because they don't know what will be in the fund over that time. And the same with principal repayments - there's no maturity so there is no repayment. So you lose the predictability which is the hallmark of fixed income in the first place. Equity is about "return on capital". Bonds are about "return of capital", and in any fund or ETF you've lost that because they don't matiure.

Fixed income ETFs only came out in 2012 in Australia and 2008 in the US. I don't think the ETF industry thought hard about the fact that they're losing arguably the most fundamental feature of the asset class: maturity. It's not about good versus bad, it's just that outcome A is very different to outcome B. XTB's can be great for people, especially older people, who want the predictable income. ETFs can be great for people who want the very broad bond exposure you get with ETFs, but the asset is locked up in perpetuity. ETFs are supposed to mirror their underlying asset classes, which they do well for most asset classes, but not for maturing bonds.

Are you guys competing against ETFs?

Most of our marketing is about comparing bond returns with returns from term deposits. It's a bit more risk for corporate bonds and you can earn another 0.5% to 1.5%. Corporate bonds are an alternative to term deposits. Bonds looks like a term deposit structurally in terms of payment timing - money in, money out, with income along the way. If you want to be exposed to 400 different bonds from 400 issuers then you need an ETF. Whereas if you want to know your duration, interest rate exposure, and have total predictability, go with XTBs.

It's been said that central banks are helping to blow a debt bubble because interest rates are too low. It strikes me that one of the advantages of your offering is that these types of blue chip debts won't get hit if a bubble bursts.

Keeping interest rates low for so long obviously makes money freely available and is causing concerns. But what we're trying to do is deal with a long term problem in Australia - not enough individual and SMSF savings are in a certain type of fixed income product. We believe that not enough superannuation money has access to this type of asset. History shows that bonds won't be correlated with equities and other asset classes when a major equity downturn comes - which it inevitably will.

Where do you guys see yourselves in five years' time?

At the moment we're covering existing bonds that were issued in the past. Going forward we want to do a primary issuance over bonds that don't yet exist. That means working with bond issuers and banks. All ETFs are really secondary market businesses, they buy securities that exist generally and offer products linked to that. But we want to go into the primary market space in a way that ETFs haven't really done. Beyond that we see ourselves going into other jurisdictions, where bond markets have similar structural problems.


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