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Perpetual Bets on Aussie Bank Bonds as Credit Rally Peters Out

Australia’s Perpetual Ltd. is betting bank paper, mortgage bonds and property trust debt will outperform as a rally that drove credit spreads to the narrowest level since 2008 peters out.

The Sydney-based fund manager favors four- and five-year senior unsecured bonds issued by the country’s major lenders because they offer an attractive yield and the steepness of the curve provides scope for capital growth, according to Vivek Prabhu, who helps to manage about A$4.5 billion ($4 billion) in fixed-income assets at Perpetual.

Credit spreads narrowed around the world last year as stocks rallied and the outlook for the world’s largest developed economies improved. The yield premium over the swap rate offered by company bonds in Australia shrank to 102 basis points in November, the least since March 2008, Bank of America Merrill Lynch indexes show. The gap was 107 basis points yesterday.

“For something that’s so highly rated and very liquid, Aussie senior bank debt offers quite good value,” Prabhu said yesterday in an interview. “Given how far credit spreads have run, it’s probably going to be a more range-bound environment.”

Perpetual’s wholesale Diversified Income Fund with A$414 million in assets returned 5.6 percent in 2013, better than 88 percent of its peers, according to data compiled by Bloomberg.

An index of bank bonds in Australia returned 5.1 percent last year, compared with 4.5 percent for industrial debt and 0.1 percent for sovereign notes, according to the Bank of America data.

Subordinated Debt

Australia & New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Ltd. and Westpac Banking Corp. are all rated AA- by Standard & Poor’s, the fourth-highest credit score, and Aa2 at Moody’s Investors Service, the equivalent of one level higher.

In addition to senior bank paper, Perpetual also sees opportunities in subordinated debt issued by lenders, particularly in some of the retail instruments that are listed on the ASX.

“Historically retail notes have been more expensive, but at the moment there is the opportunity to get better returns in the retail bond market for taking the same risk,” said Prabhu. “Some of the listed retail bonds have been providing wider spreads than wholesale paper, particularly some of the Tier 2 bank instruments, so we’ve taken positions on them.”


Prabhu is also positive on residential mortgage-backed securities and the instruments remain among his main credit investments, although he reduced holdings following last year’s rally in the debt. Some of the funds that he previously had in the sector are now in unsecured bank paper, he said.

“Spreads on bank paper are about the same as for RMBS, and even though it’s unsecured you get the added benefit of a steep curve which gives you scope for capital gains,” he said.

Notes from real-estate investment trusts are also among Prabhu’s larger positions after consolidation within the sector increased their market share and pricing power, he said.

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