June was a frenetic month in terms of news flow but one that ended much where it started in terms of bond markets.
Locally we are basically waiting to see the effect of the year’s earlier three consecutive rate rises, which if housing activity and prices are anything to go by are starting to bite. The June CPI headline was below expectations, but the policy relevant trimmed mean was a touch higher at 3.6%.
Yields are actually modestly lower in the month across the curve, unlike our US counterparts, where the new Federal Reserve (Fed) Chair Kevin Warsh presided over an unchanged cash rate but a big shake up of how the Fed will operate. US yields have risen a lot at the front end as a hike has been priced in, but the longer end was moribund, in line with us.
The biggest surprise of June was the assault on capital gains from the budget, which has been almost universally derided. The last big tax adjustment Labour tried to bring to an election resulted in failure so perhaps it is no surprise they didn’t try the same with this one. We will see if this ends up favouring income assets that aren’t exposed to CGT or if the natural Australian attitude towards risk remains undimmed.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.19% and consists of ten bonds of roughly equal weight by value to total an approximate $510k spend.
The primary issues were concentrated in the first couple of weeks of the month before things wrapped up for the end of the financial year.
We participated in new deals from Transurban, Telefonica (the Spanish Telstra) and European energy utility Engie, but none of these yielded enough to make it into this portfolio.
The sole successful switch was from Australian data centre business CDC. Originally conceived as the government’s data centre for secure government use, it has expanded into being our largest and one of only four investment grade rated data centre businesses globally.
The 7-year subordinated bonds priced with a coupon of 7.332%, which for the Baa3 rating was excellent value. The business has a huge capex buildout over the next few years but has a matching huge hyperscaler contract to back it up.
Absent a further spike in inflation, the Reserve Bank of Australia (RBA) look to be done with rate hikes. The best time historically to flip to more fixed exposure is just after they finish, so we swapped out the lowest yielding floating rate bond from Verizon.
This moves the portfolio to a 50:40 fixed to floating ratio, and we may add further if inflation moderates.
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 31% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 6.83% and is an approximate $600k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
We made the same switch as above, adding the CDC for the Verizon. The APA floater is the same projected yield as the Verizon despite being 2 years longer, but we prefer the stability of the domestic utility sector over US communications despite the credit spread duration being slightly longer.
A recession doesn’t look likely at the moment, so we are happy with this allocation even as spreads are relatively tight compared to history.
RAM issued a new unrated Over-the-Counter (OTC) bond during the month under essentially the same terms as the current listed note but with pricing ~65 basis points (bps) tighter, so we were once again happy to stay with the existing bond.
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 15 bonds, yields 7.22% and is an approximate $470k spend, demonstrating the concept of greater diversity in higher risk positions.
The two new foreign currency bonds yield significantly more than ones we had in the portfolio last month. They also allow us to manage exposure to individual issuers, which in the high yield space is critical.
The first new bond is issued by Santander, the Spanish based international bank. This USD Additional Tier capital note (AT1) is rated the same as the Nat West USD AT1 but as it one year longer offers a higher yield. With the added diversification of a new issuer, we are happy to switch the Nat West out and lower our exposure to this one issuer.
In GBP we had the existing 2032c AT1, but now there is a longer 2036 equivalent with a significantly higher yield. Despite the ongoing political ructions in the UK (which are making Italy look like a more stable democracy!) we are happy to take the longer tenor as UK bank results have been solid, importantly with good asset quality.
We are keeping in the Barclays 8.50% 2030c GBP, SocGen 8.50% 2034c and Clearview 2030c bonds for their high running yield but when new bonds are issued we will likely swap them out for higher outright yields.
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