Duration preferences
New Zealand’s local high-grade issuers are encountering divergent duration preferences within their investor bases. These include different demand patterns on- and offshore and between real-money and balance-sheet buyers.
BUTCHER A key theme we have seen in the past year is offshore investors in New Zealand Local Government Funding Agency (LGFA) bonds shifting further out the curve to find additional yield.
It is a little surprising, but I think they are not treating New Zealand as part of a duration view within their global portfolios. We are an outlier and investors continue to be relatively yield-hungry.
One reason for this could be that investors in New Zealand tend to take a long-term, fundamental-based approach. Their underlying models also show that the back end of the New Zealand yield curve is still reasonably priced relative to the front end.
Another could be that the LGFA curve is reasonably steep relative to the New Zealand government bond (NZGB) curve, such that investors receive a spread pick up of 120 basis points over NZGBs in the long end and 20-30 basis points in the short.
Offshore investors holding NZGBs or LGFA bonds could be seeing the extent to which spreads have tightened relative to US Treasuries but, with outright interest rates being low, are still happy to hold more LGFA bonds in the back end of the curve relative to other New Zealand dollar assets.
We are seeing a reduction in demand for duration from domestic real-money investors. What’s interesting is that the third investor cohort – bank balance sheets – is actually moving out along the curve. The banks have recently been showing more interest in the 2023 and 2025 LGFA lines. The 2025 is particularly interesting because this is beyond the typical five-year term one would expect to see in a liquid-assets portfolio.
Our 2023 and 2025 lines have been the best performing on the LGFA curve in the past year, largely because bank balance sheets have been switching into the mid-curve maturities from the 2019s and 2020s.
DIREEN These are the same two maturities we issued in our debut transaction. We have also largely benefited from this demand dynamic.
We are seeing a reduction in demand for duration by domestic real-money investors. What’s interesting is that the third investor cohort – bank balance sheets – is actually moving out along the curve.
BUTCHER The chase for yield in a benign interest-rate environment, I think.
JOHN These are interesting observations. In fact, at the moment we are seeing investors shortening their duration preferences in a move we certainly thought was universal and that most issuers would be seeing.
