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Better than bonds: fixed income with minimum risk - 28.08.2019

With this article, we continue the cycle related to investment solutions that provide practical answer to the question “HOW CAN INVESTOR EARN IN TIMES OF FINANCIAL CRISES?”

In the previous article, we identified a number of general rules. These rules guide investors towards earnings, regardless of the economic situation.

In this article, as well as in upcoming two, we are going to show how, starting from general rules, find specific instruments for investments that will be profitable and safe at the same time.

It is known that one of the least risky asset classes is fixed income assets. The most common instruments in this class are government and corporate bonds.

Bonds are also called debt instruments, since the issuer of bonds actually takes money from buyers of securities. Interest on the loan is paid according to prospectus. In most cases, this happens once a month, once a quarter or once every six months. Payments of bond income are also called coupon payments in memory of those times when securities had a paper basis and when paying income the representative of the issuer cut off a coupon from a paper bond to confirm that the obligation was fulfilled. The last coupon payment is usually made along with the payment of the principal. After all obligations of the issuer on the bonds are fulfilled, the issue ceases its circulation. Therefore, the moment the issuer fulfils the obligation to fully repay the loan is also called the maturity date of the bonds.

In some countries, bonds are traded on exchanges, and liquidity — the ability to turn a security into money at any time — becomes additional factor that makes bonds more attractive to investors.

However, there is a certain risk in buying and holding bonds. For example, when things are going wrong with the borrowing company, it may refuse to fulfil obligations to return funds to bondholders. In the best scenario for the investor, payments are delayed; in the most negative, investments are lost.

The likelihood of negative scenarios increases significantly during economic crises, as well as during periods of uncertainty in financial markets.

At such moments, bondholders have little choice:

  • pray that for them everything will end successfully;

or

  • try to sell securities on the market at any price, regardless of losses.

During a recession or even waiting for such a recession, the risk of default, which is always present when investing in bonds, suddenly takes on real features as more and more enterprises report losses, lower sales, inability to service bank loans and they urge investors and creditors to wait at best, and at worst simply refuse to fulfil their obligations.

Is it possible for an investor to protect himself from these risks, but at the same time continue to receive a fixed income?

After a long and thorough search, we managed to find an affirmative answer to this question.

A suitable solution to reduce the risks of investors was found in Australia, and the idea behind it is very simple:

  • firstly, loans are provided as a mortgage of Australian real estate;
  • secondly, the loan amount does not exceed 60 percent of the value of the collateral at the time of the loan;
  • thirdly, loans are granted only against collateral of objects that are not used as collateral for other loans (first mortgage); thus, even in the worst-case scenario, the lender will be the first contender for the proceeds from the sale of the borrower's property.

Further, we have already written about the impressive development of the Australian economy and the promising Sydney property market.

Therefore, we are quite confident that the Australian economy will be able to withstand very severe stresses, and, therefore, Australian real estate will retain its value even in the event of global shocks.

What is the return on such investments? Today, private investors can expect 7-7.5% in Australian Dollars per annum, investing for up to two years. Such a return is fantastic in the world of zero interest rates, but in Australia it is quite real.

Thus, we found a solution that:

  • brings in regular income, like bonds;
  • moreover, this income is higher than the yield on bonds;
  • at the same time, the reliability of such investments is extremely high, as a result of the lender’s protection by collateral, the ratio of the loan amount to the value of the collateral, as well as the priority of lender’s claims on the borrower in case everything follows an undesirable scenario.

Does this solution have flaws compared to the same bonds?

Of course.

Firstly, the loan amount will be repaid at the very end of the contract, and this is usually one and a half to two years from the date of deposit. Unlike bonds that can be converted into money on the open market, in the case of private debt you need to wait until the end.

Secondly, the amount of a single loan rarely exceeds 10 million Australian Dollars, and the entire loan portfolio at any given time is not more than 5 billion Australian Dollars.

These parameters impose restrictions on the amounts that can be allocated for investments in one project and as well as total amount of investments in private debt.

Our experts consider it safe to invest in one project up to AUD 1,500,000, and in a private debt portfolio consisting of several projects, up to AUD 150 million. These amounts at the end of August 2019 are approximately equivalent to USD 1,000,000 and USD 100,000,000, respectively.

Of course, these are not the amounts that are interesting to global investors with portfolios worth billions of US dollars.

Perhaps for the better: remaining a niche solution for small and medium-sized private investors, it is more likely to remain in that capacity for a long time.

Today, private debt institutions secured by real estate in Australia have more than 40 years of experience and tens of thousands of grateful investors.

We invite everyone to receive a fixed income with minimal risk.

Contact us for more information.

Thank you and see you soon!