Yields are back towards the levels that prevailed 15 years ago, before the “great moderation” period after the Global Financial Crisis of slow economic activity and inflation.
Higher yields provide a significant cushion against capital losses from further rate rises and bonds are likely to resume a typical defensive role in portfolios as correlations with risky assets decline.
Bonds also look more attractive versus stocks as higher yields compress the equity risk premium.
The New Zealand fixed-income market is entering a new era where Government issuance, which is significantly larger than recent years, is being efficiently intermediated to both domestic and non-resident investors.
Offshore investors — a category that includes official institutions, pension funds and asset managers — have increased their holdings of New Zealand Government bonds to $89 billion at the end of April, representing almost two-thirds of outstanding bonds when excluding those held by the Reserve Bank. Non-resident demand has reduced the impact of heavy Government issuance on the domestic non-Government fixed income market.
There is a growing pool of domestic savings, which is contributing to demand for traditional and innovative new debt capital market (DCM) products from non-government entities, that match the objectives of issuers and borrowers.
KiwiSaver
The total funds under management (FUM) in managed funds reached $213 billion at the end of 2023 fuelled by strong growth in KiwiSaver. Contributions to KiwiSaver funds totalled $10b in 2023, and have been growing at an average rate of close to 10 per cent over the past five years.
In aggregate, KiwiSaver funds allocate around 10 per cent to domestic long-term debt securities and 5 per cent outside Government bonds.
Investment into New Zealand fixed income can be expected to grow alongside FUM growth.
Fixed income will also form a key building block for decumulation strategies as larger cohorts of KiwiSaver investors reach retirement and adjust asset allocations to align with a new stage in the investment life cycle.
The retail and wholesale investor segments are vital for the domestic credit market in New Zealand, providing essential debt funding for a variety of issuers.
The retail bond market offers flexibility for issuers to tailor their deal structures to meet specific needs and preferences.
For instance, borrowers can issue resettable bonds, capital and subordinated instruments, or bonds without a credit rating — a distinctive feature of the New Zealand market, as many other markets require a credit rating for bond issuance.
Participants in the retail bond market include both retail and wholesale investor channels, enabling issuers to access a broad set of fixed-income portfolios.
The local investor landscape has undergone significant changes in recent years, with consolidation across asset manager and wealth manager channels.
Many asset managers have moved to a more passive asset allocation strategy; however, several prominent investors have retained an active approach. Large wealth managers such as Forsyth Barr, Craig’s Investment Partners, and the newly formed FirstCape (holding the JBWere and Jarden Wealth businesses) continue to service most retail bond investors.
Growth and development
Growth prospects in the wealth management industry remain strong, with investors seeking bespoke advice and favourable trends underpinning funds growth.
A developing middle-market investor base consisting of small asset and wealth managers, high-net-worth family offices, and charitable trusts complements traditional demand pools whilst maintaining broad investment mandates.
This diversity in investor type and strategy is essential to a vibrant capital market that supports product innovation and development.
Total public debt market issuance outside Government Bonds has trended consistently upwards over recent years, with about $17 billion of bond issuance and $1.7 billion of securitisation transactions in 2023 — a 24 per cent increase compared to 2019 issuance levels.
We anticipate lower volumes of supply in 2024, given the slower economy and reduced funding appetite from some issuer segments.
Nonetheless, the market trajectory remains promising, with a comprehensive range of issuers, sectors, and structures finding support from local investors.
Globally, credit markets have performed strongly over 2024, aided by a strategic asset allocation tilt towards fixed-income assets. Similar dynamics are observable in the domestic market, with many borrowers achieving competitive funding levels and, more recently, longer-tenor solutions. Funds growth and a robust pipeline of bond redemptions have resulted in elevated levels of investable cash across the market.
With only modest levels of supply, this represents an opportune time for issuers to tap into latent demand. Corporate issuance volumes have remained modest and range-bound over the past five years, with $2 billion to $3 billion of bonds issued annually.
This structural shortage of supply has been a consistent feature of the local market, with investors indicating in multiple market surveys a clear preference for increased issuance from this sector.
The New Zealand bond market is showing signs of increasing capacity, expanding potential deal sizes, and innovating in DCM products.
Longer tenors can also be supported in the right conditions, although more consistent demand would be desirable.
While some New Zealand borrowers have traditionally sought large volumes from offshore markets, the domestic market can offer competitive and flexible solutions for both investment-grade and unrated issuers, especially when engaging both institutional and retail investors. Issue sizes of up to $300 million for investment-grade borrowers are becoming common, with demand for recent transactions indicating even larger volumes are possible.
Encouragingly, investors have demonstrated capacity to support significant total outstanding volumes for highly regarded borrowers — Infratil Limited, an unrated issuer in the local market has over $1b of bonds placed with investors.
Current interest rate settings have seen a favourable tilt in asset allocation towards fixed income. Investors are comfortable taking duration risk in this environment, with appetite for longer tenors (seven years and longer) increasing.
Historically, investors have focused on five-year to six-year maturities, as these have been the most liquid tenors in the market.
Given the long-term investment horizon of many KiwiSaver investors, there is optimism this dynamic will help support more long tenor options for borrowers.
DCM trend
Another trend that has emerged over the past decade is the innovation in DCM products, which has created more diversity for investors and tailored solutions for borrowers.
The securitisation market, for example, has grown and deepened in recent years, providing efficient funding options for non-bank lenders and attractive risk/reward propositions for asset managers.
The transfer of risk through securitisation also fosters competition and access to credit for a broader set of borrowers, supporting the growth and resilience of the New Zealand economy.
Moreover, the market has seen more variety in bond structures, such as subordinated and capital hybrid instruments, callable features, and resettable bonds, which can offer higher yields, optionality, and flexibility for both issuers and investors.
Investors value issuer and sector diversity, and investment-grade-rated Australian companies issuing in NZD would receive a strong reception.
Increased market capacity supporting larger issue sizes, similar regulatory disclosures, and the relative competitiveness of the New Zealand retail market versus the wholesale Australian Medium Term Note (AMTN) market create a compelling proposition for our friends across the Tasman to consider the New Zealand market. The natural issuer would be Australian companies with direct NZD exposures, although opportunistic funders would find a welcoming audience.
The ongoing expansion of DCM products can encourage a more diverse set of issuers to enter the market, such as smaller corporates, iwi, and community-focused organisations, who can benefit from bespoke solutions such as wholesale unrated bonds or other structured credit products. The opportunity for more borrowers and investors to explore diverse funding and investment solutions is likely to continue as the New Zealand market matures and evolves.
Stuart Ritson is Senior Interest Rates Strategist at BNZ; Cameron Waugh is Head of Capital Markets at BNZ.
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