Not-for-profits (NFPs) generally invest in term deposits as their primary source of income. As term deposit rates today are very low, many are looking for defensive alternatives.
Most NFPs with excess cash have a known future cash outlay in mind. They generally need a level of certainty that their capital will be there when they need to redeem it. TDs have been popular due to their guaranteed returns and known dates for capital to be repaid.
Boards of NFPs are generally made up of people with an interest in achieving the goal of the NFP. However, they may not be financial professionals focused on investing. So it’s easy to see why bank deposits have become a stopgap for excess cash. Directors don’t have time to consider complex investment proposals, they definitely don’t want to worry about capital losses from higher risk investments. Alternatives they can consider need to be simple and low risk.
Step up to bonds for more return
Bank deposits have been at low levels for many years now. As a result, many NFPs need to increase their returns to meet their future goals. Corporate bonds are the logical next step, although they present slightly more risk for more return. Bonds are defensive investments and are generally negatively correlated to equities.
Bonds don’t enjoy the benefit of protection under the Financial Claims Scheme, but generally offer returns above term deposits. The experience for TD and bond investors is very similar. Both know who they are lending money to. Both know when they receive income (coupon) and when their capital will be repaid. Having a known outcome is the key selling point for fixed-rate bonds, like TDs. This is an important consideration for NFPs with known expenses they plan for.
The liquidity advantage
A major advantage of bonds over deposits is that bonds are bought and sold on the secondary market. However, this does mean they can experience day-to-day fluctuations in capital price. But returns for fixed-rate bond investors are set from the day they buy, assuming they are held to maturity.
Pick and choose your companies
A much wider variety of companies issue bonds – unlike TDs, which are issued only by banks. This allows NFPs to invest in line with their values. Many NFPs we have met with have an ethical or environmental focus to their investing. Bonds allow them to lend money to companies aligned with their interests. Climate Change Bonds are an example of this. They are bank issued bonds where the funds finance wind and solar projects. We have seen considerable take up in these from NFP investors. Others want to avoid companies involved in coal mining or gambling and can choose bonds to suit.
Like TDs, simplicity is at the heart of bonds
Bonds are very simple instruments. They are issued and mature at the same face value, and fixed-rate bonds pay a set coupon or return. Up to now, smaller NFPs have stayed away from bonds due to the $500k+ trade sizes required per bond. Whilst managed funds have offered access, the loss of a known outcome has been a deal breaker for many NFPs.
NFPs can buy and sell XTBs via the ASX issued in $100 units. The process is like buying or selling shares. XTBs can help an NFP to say goodbye to the traditional $500k parcel sizes associated with bonds. Most investors hold their XTBs to maturity, but ASX daily liquidity is there if it’s needed.
Don’t overlook the impact of an extra 1%
If a bond can earn an extra 1% each year vs a bank deposit, it can mean a considerable difference in the long term. For NFPs and charities the more income they receive the more good they can do.