For many years, the Challenger Ltd (ASX: CGF) share price was one that many an ASX investor probably wished they could forget. Since peaking at above $14 per share back in late 2017, Challenger shares have been in freefall.
This is a company that bottomed out at $2.82 per share in just the past 12 months. That represents a loss of 80% over three years or so.
But the Challenger share price has staged a remarkable recovery in recent months. Challenger shares were trading at $3.63 back in mid-September last year. Today, those same shares are going for $6.55 at the time of writing. That's a recovery of ~80% in just six months, not a bad return.
So what has breathed new life into this annuities company?
Well, to answer that question, we just need to look at how Challenger makes its crust in the first place.
So (as I just mentioned), Challenger provides annuities and other investment products like funds management. But annuities make up the lion's share of its business. An annuity is a pension of sorts. You provide Challenger with a lump sum of capital, and in return, you receive a fixed percentage of that capital every year as a payment.
What makes annuities unique is the certainty they offer. Most investments don't offer a guaranteed income, as we saw last year when many traditionally solid ASX dividend-paying shares reduced or axed their dividend payments. Likewise, a house or a property can provide rent, but tenants can always move out and pull the plug on your cash flow.
Annuities take that uncertainty away – in exchange for a lower yield than what you can expect from many shares and the like of course. There's no free lunch.
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A challenging time for Challenger shares
But Challenger has a difficult balancing act to pull off in order for it to make money. It has to invest its clients' funds in investments itself in order to create a spread it can take profits from. And since it is required to pay a guaranteed income for its annuities, it has to make sure it doesn't lose too much money.
Unfortunately for Challenger, the best risk-free assets – government bonds – have not had a good few years. The Reserve Bank of Australia (RBA) has been slashing interest rates progressively over the past few years (and aggressively last year). As such, government bond yields and cash interest rates have also been cratering.
Fortunately for Challenger though, the past few months have seen this situation reverse, and government bond rates rise substantially.
In November last year, 10-year Australian government bonds were yielding just 0.88% per annum. Today, those same bonds are instead offering 1.65%. At the same time, the S&P/ASX 200 Index (ASX: JXO) has been rising in tandem. As have ASX 200 dividends.
This might just be why the fortunes of the Challenger share price have been rising as well.
