About a month ago we ran this note along with a sample portfolio. It had great readership, and the markets have moved already, allowing us to show the impact on the various holdings, so thought we’d provide an update
The sample portfolio has been updated from 29 August, when it was originally published to 26 September, exactly four weeks later. Changes in yields can be seen in the table below.
Source: FIIG Securities
Note: Yields accurate as at 29 August and 26 September 2017, but subject to change
RMBS August yields have been restated
Changes highlighted in green are positive as the yield has declined, and bond prices have moved higher
Red signals that yields have moved higher, causing the bond price to decline
Previous portfolio description
The portfolio contains approximately 30% of government or semi government bonds which give downside protection, 26% high yielding USD bonds which really increase the overall yield and income (and hopefully despite being high yield will be hedged in AUD terms in a recessionary type environment by the currency effect), and the remaining 38.4% in AUD investment grade bonds (which history tells us have defaulted only three times in the last 30 odd years) plus a small allocation of 5.6% to AUD high yield, again to pick up the income.
The weighted average term to maturity is relatively long at 9.5 years, but given the higher yielding bonds providing high income, the duration (interest rate sensitivity) is relatively low at 4.34 years.
The overall design is for different parts of the portfolio to perform at different times, resulting in an overall stable capital outcome and at the same time a large pick up over cash yields.
The main movements in the market have come in the largest holdings. NCIG has rallied $9 in price with the yield reducing by over 1% as they have refinanced senior debt, making the overall structure more stable. The government bonds have gone the other way to a lesser extent, with yields rising by circa 0.15% on all three bonds as the economic outlook has improved. Given these are the largest positions, this effect has broadly offset.
Other big moves came from USD high yield Hertz, down 0.90% while the only significant under performer was the USD Frontier bond, whose yield increased by 1.24%.
As the allocation to Hertz and Frontier was roughly the same with face values of USD20,000, the moves largely cancel each other out. The AUD bonds have generally followed credit spreads tighter too, with the RMBS remaining stable given no real movement in housing.
As I initially constructed the portfolio to have separate parts which perform in different ways depending on the shifting markets and environments, it is pleasing to see this has worked so far, with credit (corporate bond) yields contracting while rates (government bonds) have widened. The diversification effects are apparent too, as some of the high yield bonds have rallied while others have sold off – demonstrating why investors should opt for a greater number of smaller, high yield holdings.
Overall, the yield to maturity on the portfolio has declined slightly from 5.04% to 4.97% per annum. The running yield has also marginally decreased from 5.70% to 5.68%.
Please see the other WIRE note this week – ‘Places to hide when tensions escalate’, to better understand the function of government bonds in a portfolio.
For more information, please call your local relationship manager.