Two of our most senior relationship managers, Jake Koundakjian from Queensland and Michael Cooper from Victoria, make some suggestions for your portfolio
Jake Koundakjian, QLD
Recently, I’ve taken a more cautious stance due to a few dark clouds on the horizon including:
- Rising interest rates around the world – due to less stimulus which will act as a drag on GDP
- Tariffs act like a tax reducing growth – lower GDP
- Psychological changes in growth type investment assets like Bitcoin, Tesla & FANG shares coming off the boil
- Flattening yield curve typically is a sentiment indicator pointing to scepticism about future economic growth, see this article
In addition, head of Research, Mark Bayley circulated this article from global fixed income investment manager Pimco that is worth a read. Here are my takeaways:
- The global economic expansion has already entered its 10th year
- Late cycle booms typically mark the beginning of the end (typical for oil to outperform during late cycle from past cycles)
- Central Banks focusing on removing accommodation, which looks likely to turn restrictive over the next couple of years
- Risk of an inflation overshoot means pressure for central bankers to push rates higher and higher (floaters & inflation linked bonds beneficiaries)
- Credit spreads start to widen well before equities peak. Investors should consider moving into the safer parts of the credit spectrum such as Residential Mortgage Backed Securities
- There is nothing in the economy or financial data to suggest a global recession is imminent
- There may be room to run for another year or maybe two, however the risk of recession thereafter is high and rising
- It is time for investors to prepare for a potentially long period of more volatile and plateauing asset prices because it often precedes bear markets for risky assets
No one can predict what tomorrow will bring but perhaps it is time to consider tilting towards more defensive assets.
With these thoughts in mind, here are a few of my suggestion for a more defensive allocation:
|Issuer ||Rating ||Call date ||Maturity date ||Coupon rate ||Type ||Yield to worst* |
|Liberty Financial ||BBB- || |
|1-Jun-20 ||5.10% ||Fixed ||4.3% |
|Challenger Life Company ||BBB ||24-Nov-22 ||24-Nov-42 ||3m BBSW+2.1% ||Floating ||4.0% |
|Insurance Australia Group ||BBB ||15-Jun-24 ||15-Jun-44 ||3m BBSW+2.1% ||Floating ||4.3% |
|Sydney Airport ||n/a || ||20-Nov-30 ||3.12% ||Inflation linked ||CPI+2.92% |
|Higher quality RMBS ||Investment grade || || || ||Floating || |
Note: *Prices accurate as of 1 May 2018, subject to change
# Inflation Linked Bonds assume CPI at 2.5% in the yield calculation
Michael Cooper, VIC
Strategist and economist Craig Swanger detailed in prior WIRE notes that a reversal in the interest rate differential to a position where rates in the US are higher than those in Australia will ultimately result in higher AUD values for USD denominated bonds and that this is an income opportunity for Australian investors. In making that statement Craig is referring to investment flows leaving Australia and moving to the higher yielding USD investment.
In a brief article from Bloomberg, Buy Australian Bonds, Sell the Currency: Morgan Stanley - by Masaki Kondo 26 April 2018 6:00 AM, Morgan Stanley Investments reiterate the view in detailing why they remain underweight the Aussie dollar. The article can be found here
Here’s an excerpt:
“Australian short-term interest rates are below those in the U.S., he said. “You pick up yield by selling the Australian dollar for the U.S. dollar, you actually earn incremental yield. It’s the cheapest it’s ever been to sell the Australian dollar today.’’
It would seem that with every day that passes we move closer to an accelerated appreciation in the AUD value of USD denominated bonds.
What about interest rate risk?
The forecast higher US Fed Funds rate and US inflation expectations are built into the current US interest rate curve. Therefore as cash rate hikes eventuate in the United States you should NOT expect bond rates beyond circa two years to alter unless current expectations change.
For over 12 months I have been calling a fair value yield range for the US 10 year Treasury bond of 3.00%pa to 3.25%pa. We could overshoot if inflation surprises to the upside however we are clearly in my value range.
Given the above outlook for international capital flows and given US interest rates now in what I would regard as a value range, Australian based investors from an underlying interest rate point of view, should be comfortable holding USD denominated bonds. From a risk perspective for corporate bond investors, the focus now needs to turn toward bond trading margins (additional interest for the credit).
It you are looking to initiate or add to USD denominated bond holdings there are a range of alternatives. One that I like is the BARMINCO-6.625%-15May22-USD.
Its unique position within the underground mining contract market coupled with around four years to maturity satisfies my credit and interest rate risk requirement. However what’s really exciting is the possible return if called early!
As you are aware, we’ve regularly seen companies come to the market and manage near term debt commitments by issuing longer term bonds and ‘calling’ nearer term bonds.
The yield to maturity on this bond is an attractive 6.71%p.a. (annual income 6.645% p.a.)
The table below sets out yield to call analysis.
Ausdrill has had its sights on Barminco as a possible takeover target. This gives rise to another reason as to why the May 2019 call may be in play.
The bonds are rated a single ‘B’ and minimum parcels are USD10,000 costing A$13,576.91 for wholesale investors only.
Link to Research/Updates: HERE
Link to Company Website: HERE
For more information, please call your local dealer.
Director, Fixed Income Sales, QLD (07) 3231 6629
Jake grew up in Ottawa, Canada, where he rose from a teenage bank teller to a portfolio manager overseeing more than $600 million in assets for the Bank of Nova Scotia. With over twenty years in asset management he moved to Australia seven years ago with his family.
Director, Fixed Income Sales, VIC (03) 8668 8821
Michael started in the markets over thirty years ago having held senior positions with a number of institutions including Barclays and N M Rothschild and Sons. He's lived most of his life in Sydney as well as Singapore for a short period before residing in Melbourne in 2013.