Bloomberg News

Pension Funds Punished for Lowest Bond Stakes: Australia Credit

September 15, 2011

Sept. 15 (Bloomberg) -- Australian pension funds, which manage the world’s fourth-largest pool of assets, are being punished for the lowest allocations to bonds among developed nations as fixed-income securities beat stocks for the longest stretch since at least 1997.

Australian superannuation funds posted a 0.9 percent loss in the second quarter, according to the Australian Prudential Regulation Authority. About 11 percent of the $1.2 trillion in Australia’s retirement funds was invested in bills and bonds last year, the least of 27 nations tracked by the Organization for Economic Cooperation and Development. Forty-seven percent was in equities, the most after the U.S. and Finland.

Debt in Australia has gained every month in 2011 while stocks have lost 11 percent since Dec. 31, based on the Australian Stock Exchange Accumulation All Ordinaries Index. Sovereign securities are poised for their best year since 2008 as near-zero interest rates in the U.S., Japan and Switzerland, prompt investors to buy the South Pacific nation’s higher- yielding bonds.

“In Australia we still have this cult of equity even though bonds have provided much better returns over the past five years,” said Vimal Gor, the Sydney-based head of income and fixed interest at BT Investment Management Ltd., where he oversees A$13 billion ($13.3 billion). “We’ve got a lot of great companies here in Australia but you can’t really expect the Australian equity market to be unaffected by a global storm.”

Above Average Returns

The country’s debt has offered the second-best returns since Dec. 31 across 26 markets, while its stocks were the third-biggest losers among developed Asia-Pacific economies, according to data compiled by Bloomberg. The median return on bond funds in Australia was 3.7 percent for the three months ended Aug. 31, compared with an 8.2 percent loss for equity funds, Morningstar Inc. rankings show.

“If global equity markets continue to come under stress we fully expect further gains in sovereign bonds,” Gor said.

Australian federal debt has returned 10.9 percent this year, behind only the 11.1 percent for Swedish bonds among markets covered by Bloomberg and the European Federation of Financial Analyst Societies. Australian notes rallied 20 percent in 2008.

Stocks Lose

The All Ordinaries index of the stocks of Australia’s 500 largest companies has lost 0.3 percent for investors since Aug. 31, 2006, compared with a 43 percent return for Australian bonds in Bank of America Merrill Lynch indexes.

Retirement funds delivered an annual average net loss of 2.8 percent from 2008 to 2010, the worst performance after Estonia’s negative 3.7 percent, the OECD’s “Pension Markets in Focus” report released in July showed. The weighted average return for 26 markets was 0.4 percent, with the U.S., Japan, U.K. and Australia the four largest, the data showed.

“In most OECD countries for which we received data, bonds -- not equity -- remain by far the dominant asset class,” the OECD said in its report. Countries where equities make up 30 percent or less of the overall portfolio have suffered less from turmoil in global stock markets, the report said.

Before 2008, the All Ordinaries stock index rose in nine of the previous 10 years with BHP Billiton Ltd., Rio Tinto Group and Commonwealth Bank of Australia contributing most to the advances.

BHP, Rio Gains

Gains in BHP, the world’s biggest mining company, and Rio, the second-largest, have been driven by Chinese imports of Australian commodities including iron ore and coal. The value of the nation’s iron ore exports surged to A$5.3 billion a month in July from A$356 million in December 1997 and coking coal shipments climbed to A$2.4 billion from A$548 million at the end of 1997.

“We stand out globally as having a bit more of a growth or equity bias across allocations in super funds,” said Susan Buckley, head of global fixed-interest at QIC, which manages about A$25 billion in bonds and cash.

Australia’s growth prospects prompted central bank Governor Glenn Stevens to raise benchmark borrowing costs seven times beginning in October 2009, to 4.75 percent in November 2010 to help control inflation.

China is Australia’s largest export market followed by Japan, South Korea and India, Australian government data show.

Aussie Dollar

The central bank’s actions spurred gains in the Australian dollar to as much as $1.1081 on July 27, its strongest level since being freely floated in 1983. The currency traded at $1.0211 as of 2:05 p.m. in Sydney.

Higher yields and the links to Asia have drawn foreign investors seeking alternatives to fiscal crises and slower growth in Europe and the U.S. Seventy-five percent of Australia’s sovereign debt was held by offshore investors in the second quarter, up from 73 percent in the previous three months and 63 percent at the end of 2009, according to data from the Reserve Bank of Australia and the statistics bureau.

Three-year sovereign yields in Australia slid 1.79 percentage points this year to 3.48 percent today, heading for the biggest decline since 2008’s 3.82-point drop.

The next 1 to 1.5 percentage points of change for the three-year bond yield is “most probably lower not higher,” said BT Investment’s Gor. The flagship A$760 million BT Government Bond Fund has delivered 89 basis points more in returns than the UBS Government Index in the eight months ended Aug. 31, he said.

Yields Fall

The benchmark 10-year bond yield has fallen 26 basis points, or 0.26 percentage point, in September to 4.11 percent. That’s down from this year’s high of 5.84 percent in February and compares with 1.98 percent on similar-maturity notes in the U.S., 1.88 percent in Germany and 0.99 percent in Japan.

A drop for September would mark the ninth monthly decline in 10-year rates, the longest stretch since at least 1978.

“Rather than saying interest rates are too low, investors should be more concerned about what low rates are telling them about economic growth and expected returns on risky assets,” said Robert Mead, a money manager in Sydney at Pacific Investment Management Co., which oversees the world’s biggest bond fund.

The OECD slashed its growth forecasts for the U.S. and Japan this month and said central banks around the world should be ready to ease monetary policy to aid their economies.

Cash Futures

The U.S. economy will expand 1.1 percent in the third quarter and 0.4 percent in the fourth, instead of the 2.9 percent and 3 percent predicted in May, the OECD said Sept. 8. Japan will grow 4.1 percent in the third quarter before stalling in the fourth.

Cash-rate futures show traders are wagering that the RBA will reduce Australia’s benchmark to 3.80 percent by December.

The MSCI World Index of stocks has dropped 5.2 percent in September, heading for its first five-month losing streak since a six-month retreat completed in November 2008. The Australian All Ordinaries Index is down 5.4 percent.

While pension funds have responded to those declines by paring equity holdings, they’re favoring investments such as private equity and infrastructure rather than adding bonds, said Pauline Vamos, the Sydney-based chief executive officer of the Association of Superannuation Funds of Australia Ltd.

APRA data show that 29 percent of retirement assets were invested in Australian equities as of June 2010, with 23 percent in international stocks and about 16 percent in fixed-interest investments.

‘Spreading Their Risk’

“Pension funds are investing longer-term and they’re looking at spreading their risk as much as possible,” said Vamos, whose organization’s membership represents more than 90 percent of Australians holding retirement accounts. “I’m not sure we’ve going to see much of an increase in fixed interest because of the global financial crisis since it was seen to be so volatile and illiquid in the end.”

Concern the global economic recovery is stalling has boosted the perceived risk of Australian corporate bonds.

The Markit iTraxx Australia index of credit-default swaps rose to 194.8 basis points on Sept. 12, the most since July 2009, according to data from CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The gauge surged to 443.3 in March 2009 amid the credit freeze following the collapse of Lehman Brothers Holdings Inc.

The index dropped 3.5 basis points to 183.5 basis points as of 10:35 a.m. in Sydney, according to Credit Agricole CIB prices.

The spread between the interest Australian banks pay when borrowing from each other for three months and swaps tracking expectations for the RBA’s benchmark fell four basis points today to 55 basis points and closed at 61 basis points on Aug. 8, the highest since January 2009. The gap is a gauge of banks’ difficulty in accessing funds.

The extra yield investors demand to own company bonds in Australia instead of similar-maturity government debt fell to 224 basis points yesterday after reaching 227 on Sept. 12, the most since December 2009. It widened to as much as 433 basis points in April 2009, according to Bank of America Merrill Lynch’s Australian Corporate & Collateralized Index.

Australian Treasurer Wayne Swan today introduced legislation allowing financial companies to sell covered bonds at home, a move the nation’s Treasury estimates may lead to A$130 billion ($133 billion) of sales.

The law will amend the nation’s Banking Act to allow domestic lenders to sell the debt for the first time.

--Editors: Garfield Reynolds, Edward Johnson

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net


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