Liquidity key to retail bond innovation

Retail is detail. The development of retail bonds is no exception and liquidity is the key detail to resolve as capital markets prepare for a new wave of innovation in the fixed-interest sector.

The perspective comes from Henk Viljoen, head of the country's leading fixed interest team at STANLIB, South Africa's largest unit trust company.

Viljoen welcomes bond market innovation notably the planned 'range extension' by the Johannesburg municipal bonds programme into retail bonds but believes tradability will become the crucial issue as product developers look to exploit retail bond demand.

The planned Jozibond issue has addressed the challenge by partnering with Standard Bank. Creating a relationship with an institutional market-maker to provide support for the bond-buyer can be vital, says Viljoen, a frequent winner of fund performance awards in the fixed-interest category.

Viljoen notes: "I was pleased to see one of the key product features of the planned Jozibond is assured liquidity.

"The retail bond market was initially developed by the government in May 2004, but tradability of its retail bonds was never part of the product offering.

"If you want to compete you need a point of difference and liquidity is almost always a key feature."

Government's retail bonds allow the investor to commit between R1000 and R1 000 000 for two, three or five years and have raised R2.1 billion in a little over three years. But the bonds cannot be traded. Lack of liquidity is presented by government as a product benefit as the buyer cannot be exposed to market risk if there is no market.

However, says Viljoen, "if you target fixed-interest products at mid and upper-income investors, liquidity by trading in your securities at any time can be a big advantage."

The government has issued both retail and inflation-linked bonds. The latter started in July 2007, offering maturities of three, five and ten years. The bonds are marketed through the RSA Retail Bond website, post office branches and directly from the National Treasury.

Viljoen says government has successfully targeted the conservative saving niche while lack of tradability creates a stable funding base. But copycat product developers are at a disadvantage with any 'me-too' bonds as they cant match governments low-risk profile.

In 2004, the City of Johannesburg became the first municipality to issue bonds. Its offerings have been massively oversubscribed by institutional investors.

The city's upcoming retail bond issue is planned before year-end and will raise a further R1 billion. This time the principal target market is the private Johannesburg citizen.

Johannesburg has been so successful at raising money for capital programmes on the run-in to 2010 that Gauteng is now examining the possibility of further issuances by consortiums of local municipalities. 

Henk Viljoen points out: "STANLIB applauds innovation, but issuers must have a clear idea of the type of investor they are trying to attract and what competitive advantages they offer.

"Failure to create a trading mechanism means governments retail bond competes largely against fixed deposits from the banks.

"The direction taken by the developers of Johannesburg's retail bond suggests it will behave much like a money-market instrument, offering competitive wholesale interest rates for retail investors.'

If returns on the new Jozibond's are competitive, say STANLIB's fixed-interest specialists, the liquidity aspects may attract institutional support, though the issuer could limit the extent of institutional take-up to preserve the instrument's retail character.

"The chance to tap new sources of funding is attractive to municipal treasuries and in the past the market has shown a good appetite, with some issues being substantially oversubscribed," says Viljoen.

"But a stampede into the bond market would not be appropriate. Investors will scrutinise product quality, the return, risk and the issuers credit rating. 2010 may only be three years away, but a judicious approach, good professional advice and thorough planning are necessary. Get the detail right first."