Markets have certainly turned since the last update at the end of 2018. We had just come off the worst December in nearly a decade, and sentiment was decidedly bearish. Then Santa Claus (aka Jerome Powell) sprinkled his magic dove dust on the expectations of two or three further rate hikes in 2019 and we were off to the races again, with equities posting their best January in nearly a decade, and risk coming back on to global markets.
What this has meant for the portfolio is that the riskier high yield bonds have almost all rallied, as well as the USD. In Australia, the tone was much less bullish, with softer data and the RBA admitting that the economy wasn’t as rosy as they had first thought, significantly pivoting from their mantra that “the next move in rates is more likely up” to “the probability of a rate move either up or down is finely balanced”, which given the lack of previous optimism meant that they think it might well be down. Government yields fell across the curve, benefitting the portfolio’s longer dated positions.
All three of these things worked out in the portfolio’s favour, and as such we have rebounded strongly from the December update, when they largely went against us.
It is important to note the lack of overall volatility in the portfolio. In the worst and best months in a decade in the equity market, with December down 10-15% and January up around 6%, the value of the portfolio moved by only ~1% overall.
This exemplifies the benefits a diversified bond portfolio can have on overall portfolio volatility, whilst still not sacrificing returns. At the end of December when all the main drivers went against the portfolio, it had still returned 5.45% since inception (26th Aug 2017). Now when the tide has turned again, it has returned 6.5%.
I have taken the opportunity of some attractive new issues to rebalance certain positions which were available for optimisation.
I participated in the two new deals from Virgin and Liberty. I sold the Maurice Blackburn bond to fund Virgin, realising an 11.56% return, and sold the DBCT 2021 bond to fund Liberty, moving one notch down the credit spectrum from BBB to BBB-, lengthening tenor by 9 months but increasing yield by nearly 1%.
My overall outlook is still relatively bearish, and I think the Federal Reserve are done raising rates – they may have even gone too far already, which doesn’t say much for the strength of the global economy if it can’t handle 2.5% overnight USD rates. As a result, I extended duration in the highly rated portion of the portfolio, selling the ACG 2022 government bond, which was starting to pull to par given its high capital price, and bought the Queensland Treasury Corporation 2033 bond.
This may impact my liquidity if a recession comes as the semi government bonds are not quite as liquid as government bonds, but I remain confident that I should be able to sell it if I need to, when I want to.
I am still keeping my eye on the Pacific National 2027 fixed rate bond as a sell target, given longer dated corporates have rallied quite well this year, and I have extended the duration with the QTC 2033. I like the security of the Transurban 2024 FRN, but the yield is perhaps a bit low for the BBB rating. I will also keep an eye on this one for possible switches.
With the new issues, I now have overweights in both Virgin and Liberty. This merits close attention, as it reduces the diversification within the portfolio, and I will look to deal with this over time, hopefully by selling the Virgin if it rallies like the 2023 maturity did, into a new FIIG-originated issue. I prefer high yield exposure in USD at this stage apart from new issues, so would look to keep the shorter 2021 bond in USD of the two holdings.
Liberty is less of a concern with its investment grade rating, and huge Tier 1 capitalisation of over 15%, but none the less I will stick to good portfolio discipline, and probably look to sell the 2020 maturity into something else. The upcoming Incitec Pivot new issue may provide some value.