Jon Sheridan, joint national head of private client solutions discusses recent trades for his $1 million portfolio, providing fantastic insight for new and existing clients. Over the last two months Jon bought three new bonds but sold four.
Well it certainly has been interesting in markets since the last update at the end of October!!
Large equity pullbacks in December, meant the major US indices ended in negative territory in 2018- the worst result since 2011. Credit markets also felt some pain, with the US HY index spreads trading circa 100 points wider, marking an approx. 30% move (from 300 to 400bps spread over US Treasuries).
High grade government bonds did finally show their non-correlated side, with Treasury yields falling by approx. 30bps over the month, although this hasn’t been enough to make up for the rise seen for the rest of the year (10yr +30bps in 2018). Fortunately Australian government bonds traded below US counterparts, and have seen lower yields across the year (10yr -35bps in 2018).
The value of maintaining a diversified portfolio holding a range of bonds including high grade and high yield has never been more apparent, with almost every asset class showing a negative return for the year apart from cash.
The principle of this portfolio, which is to hold larger positions of safer bonds, diversify across smaller positions in the high risk section of the portfolio and take this exposure in unhedged USD has paid off in the year, with most bonds having their time in the sun at different times, but overall the portfolio has performed as expected, and even added some treasured alpha, or outperformance from a selected number of trades.
Since the last update, the trading has been focused more on risk management and less on opportunity.
This involved cutting a position unlikely to recover materially, in JC Penney, taking a 7% loss in AUD terms. The currency effect worked a little here, cushioning the loss by approx. 3% from the USD loss of 10%.
I also took profits on the Transocean position, which stayed relatively strong in the face of declining oil prices (which I think are likely to remain structurally low for some time). Given the price action of the bond in December this proved prescient, but was not expected to play out in such a short time frame! The position realised 12.4% in AUD terms since inception, with the currency giving 7.5% of that return.
On the opportunity side, I took advantage of AMP’s woes to rotate out of two other floating rate positions into the new subordinated bond issued in early November. Offering an attractive margin of 2.75% over BBSW, this was a great option to increase yield while still maintaining credit quality, so I sold AAI 2022c and Seek 2022, using the proceeds from these two bonds to fund the AMP position.
This leaves me with a somewhat overweight position in AMP, but with a strong investment grade rating I am happy with this for now – I may reduce it in future if a better relative value play comes along but until then I am comfortable.
Overall performance since inception is still strong at 5.45% p.a. although well down from the October update when currency had worked in my favour but the high yield price falls had not yet materialised. The November and December performance of Bristow, JC Penney and Rackspace in particular dragged down the rest of the portfolio despite the rally in the government yields.
This is relatively typical with credit leading the way, riskiest first, and if we do have the recession/major correction then government yields and the AUD should fall during this period, and HY should recover quickly, delivering rebound gains.
If all of this does go to plan, I will sell the HY, repatriate to AUD, sell the government bonds and then buy lots of cheap bonds locally, typically oversold investment grade credit. Longer term clients will remember the days of Swiss Re trading in the $50s yielding over 10%!!!
I am clearly not hoping for a global recession, but it is looking a lot more likely than it did a year ago – the US yield curve has begun to invert in places, and a macro trader I follow on Twitter commented recently that adjusting for the effects of QE (Quantitative Easing) by the US Fed, the curve actually inverted a year ago. This is important as historically this has been the most reliable recession indicator, with an average period of approx. 12-24 months from inversion to recession.
2019 is certainly shaping up to be a very interesting investing year!!
Note: Yields accurate as at 14 January but subject to change, please call your relationship manager for more information on any of the bonds.
If you are interested in learning more please see the FIIG website for our sample portfolios or call 1800 01 01 81.