In the last month yields across the curve have risen about 0.50%, despite the US Fed cutting overnight rates by the same amount. This apparent contradiction, of higher market rates but lower central bank rates (usually due to a slowing economy), looks
to have 2 main explanations.
Firstly, when the first rate cut was priced in by the markets, it very quickly was followed by the anticipation of lots of further rate cuts, which brough yields arguably too low for reality given the economic data, which until Friday’s weak US
jobs number, have been remarkably resilient.
Secondly, there is the small matter of the US election which should have a preliminary result by the time we go to print. Over the last month it seems the market has been pricing in a Trump win and the potential for even more US Treasury issuance, which
will have to come at higher yields to entice buyers.
Time will of course tell where we go from here. At the moment, we are still of the view that the macro-economic slowdown will likely overpower (I deliberately didn’t say ‘trump’!) the extra issuance and are keeping the longer duration
bonds.
This month there was a lot of primary market activity with lots of new bonds to evaluate for the portfolios.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.75% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
As a reminder, the portfolio contains a government and semi government bond with low yields. These are not expected to be held to maturity, but instead traded if and when yields fall. Therefore, the portfolio yield is understated compared to expectations
given it is unlikely this low yield to maturity will be realised on these bonds.
Additionally, the inflation linked bonds have an assumed 2.5% inflation rate in their yields. With inflation having been high and now stubbornly refusing to come down, these bonds may also return more than currently forecast.
Of the newly issued bonds in the month, almost all were of interest to this all-investment-grade portfolio.
First cab off the rank was a new subordinated bond from Bank of Queensland. Whilst rated a notch lower than the BNP floating rate note we had in the portfolio, we believe the 0.40% extra yield is more than enough to take the marginally higher risk.
Staying in floating rate land, Hollard insurance issued their second subordinated bond, to a whopping 7x oversubscribed order book. Given the Liberty Financial 2029 is rated the same at BBB and with a lower yield and much higher capital price, we sacrificed
the higher income for a better overall yield and switched the Hollard in. AMP also did a 3-year senior floater at +21.0% but this wasn’t high yielding enough to make the cut.
In fixed rate bonds, Melbourne Airport issued an 8-year secured bond. The yield wasn’t enough to force into the portfolio though, unlike the inaugural issue from German state-owned electricity company EnBW. EnBW is also at the forefront of green
energy transition in Germany, providing a secondary characteristic that attracted us. Rated A-, the 10-year senior bond yields just under 6%, and diversifies away from the heavy financial allocation as we switched out the NAB 2034c and a small pickup
in yield.
Balanced portfolio:
The Balanced portfolio adds higher yielding bonds to the base Conservative portfolio to achieve a higher yield, while maintaining a balance between risk and return, skewed towards preserving capital rather than chasing yield.
It aims to have between 15-20 positions, with the high yielding bonds in smaller parcel sizes (comprising 27% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 6.74% and is an approximate $610k spend.
This portfolio, by virtue of the high yielding allocation, has a much shorter duration than the Conservative.
We made the some of the same changes in this portfolio as above, switching Hollard and EnBW for Liberty and NAB.
Credit spreads tightened slightly over the month, offsetting some of the rise in risk-free yields, which benefits this portfolio with higher credit exposures.
There were no new high yield issues this month, so nothing new to evaluate against the current high yield portion of the portfolio.
The price changes brought further opportunity in foreign currency bonds, which we don’t include in this mandate, but can do in the high yield portfolio as below.
High-Yield portfolio:
The High Yield portfolio looks to generate a higher yield while still looking to have a bias towards as low risk positions as possible.
This is achieved by good diversification and attempting to identify fundamentally mispriced bonds.
The current portfolio has 17 bonds, yields 8.11% and is an approximate $525k spend, demonstrating the concept of greater diversity in higher risk positions.
This month we have reviewed the GBP options at hand and have added a new bond to the menu issued by mutual lender Nationwide. This is an AT1 from their capital stack and has a sub investment grade rating form S&P and an investment grade one from Moody’s – it is called a crossover credit.
With a yield above 7% it deserves inclusion in the portfolio given the superior risk/return offering. The lowest yielding bond in the portfolio last month was Emeco, so we switched that out to include Nationwide.
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