The story of October was a tale of two halves. Quiet markets with rates moving gradually up each day in the first fortnight, and then a flurry of new issues in the last 10 days or so with rates relatively steady until the last week when we saw divergence with US rates falling strongly but AUD rates up small again.
It was almost as though traders were too busy with all the new stuff to think about the economics!
The US economy had a really strong GDP print but other indicators are slowing materially which is even more confusing. Equity markets were up 6-8% in just the last week of the month.
Direction is tricky here which is why a balanced portfolio is such a good idea.
The new issues were all very strongly supported by the market, but only one was of such good value that it displaced an existing bond in the portfolios.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.79% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
The only new issue to make it in was the new AMP Limited senior 2026 bond, issued with a strong margin of +3.15%. This makes a forecast yield of 7.11%, which is great value compared to the AMPOL 2027c we had in the portfolio. The trifecta of switches is higher yield, shorter tenor and higher rating. The AMP is shorter (and not callable as it is senior), higher-yielding and the same rating – pretty compelling.
BPCE, a French bank, issued a 2033 senior bond at 7.623% but by month end it had rallied to just a tick over 7%. For the extra 5 years, we preferred to stay with the Lloyds Bank. When we increase duration no doubt this one will come back into play.
The Pepper RMBS is also due for switching to a BBB-rated equivalent. As mortgage arrears normalise after the ultra-low COVID period we are comfortable coming back to a more suited BBB exposure at a margin of around +3.75% which is 1% higher than the A-rated bonds, although only in prime pools to minimise the risk.
One to look out for next month.
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 7.91% and is an approximate $575k spend.
In this portfolio we made the same change as the Conservative, swapping out AMPOL for AMP. Lots of acronyms…
The slight floating overweight helped the portfolio as yields rose in the month, but margins on these floaters contracted at the same time due to more demand than supply, leaving the overall portfolio yield little changed.
We will also look to refresh the RMBS holdings next month to see where we can pick up risk-adjusted yield.
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 10.35% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher-risk positions.
The only new issues relevant to this portfolio in the month were RMBS. As mentioned above we will refresh all RMBS exposures next month as the margins are attractive.
For example, Pepper issued a BB-rated note from a prime pool at a margin of +6.20% for a forecast yield of well over 10%, but the issue size was small as usual.
These are the kinds of exposures we will debate next time around.
The coupon income of the portfolio is strong, with a running yield of just under 8%, so collecting coupons is no hardship at all.
We are contemplating moving away from USD exposures in higher quality portfolios but as this is a high yield portfolio we may stick with them. More to come as the situation unfolds.
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