September has been another quiet month with the main story being longer-term rates moving up relatively aggressively.
The commentary for central banks has been consistent globally. While keeping cash rates on hold, the accompanying statements have all stressed the message that inflation should not be treated as having been conquered and that further rate hikes may be necessary.
In the US in particular this has changed market pricing on the longer-end of the interest rate curve as the narrative has shifted from imminent hard landing to maybe the economy can actually handle these higher rates for a longer period than previously expected.
The jury is still out on that one for me.
The portfolios are all typically shorter in duration than 10 years, averaging between 2-3 years, so have been spared the worst of the impact of the longer-end yield moves upwards.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.80% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
With no new investment grade issues of any note in the month (Suncorp did a new subordinated floating rate issue but it was very standard and didn’t meet the value criteria for inclusion) there were no changes to the portfolio.
The good news in this circumstance is that when the portfolio has a running yield of well over 6%, no changes mean it is still picking up strong coupon income.
Additionally, given the sporadic nature of RMBS availability, we keep the A-rated Pepper bond in the portfolio when we could have switched it out for a BBB- Liberty bond that we traded during the month for a nearly 2% pick up in yield.
However, as the availability of that particular Liberty bond was limited, we decided against making this change just for form in the published portfolio.
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 38% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 7.94% and is an approximate $575k spend.
In the unrated space, Pepper Money issued a new bond during the month. An attractively priced short dated high margin floating rate note, the question arose as to which of the current bonds should be switched out to accommodate this new bond.
Given the portfolio is already slightly overweight floating rate notes, appropriately so given the interest rate environment, and the lowest-yielding candidates being Emeco and Partners Life, in the end we plumped to keep the floating exposure the same and chose Partners Life to remove.
Partners, while having been taken over by Japanese life giant Dai Ichi Life, doesn’t have an unconditional guarantee from its new parent, and also keeps the unrated exposure whereas Emeco is rated.
High Yield portfolio:
The High Yield portfolio looks to generate a higher yield while still looking to have a bias toward as low-risk positions as possible.
This is achieved by good diversification and attempting to identify fundamentally mispriced bonds.
The current portfolio has 16 bonds, yields 10.29% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher-risk positions.
Including the Pepper Money bond in this portfolio was more straight-forward than in the Balanced portfolio.
Given the high yield market is overwhelmingly fixed rate, it was a good opportunity to add some floating exposure, and also we could take out the lowest-yielding bond in the portfolio which has an investment grade rating from S&P.
The BNP 2025c is due to be repaid in Jan 2025, and with the Pepper being a September 2025 call it also doesn’t materially extend the maturity profile of the portfolio but does add 0.20% to the yield.
We recognise of course that being unrated Pepper is riskier than BNP, but this is a high yield portfolio and so is staying true to purpose.
We also rejigged a couple of the face values of the USD bonds to match the minimum increments they are available in. There was no impact to the portfolio value and a marginal increase in yield of 0.04% resulted.
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