With market interest rates falling rapidly over the month – the Australian 10 year bond fell from 1.36% to 1.18% over the course of July – holding existing longer dated positions (in line with the consistent strategy held since inception) was the most advantageous position to be in.
The market for new opportunities that fit the mandate of the portfolios was very thin. The major banks (apart from CBA) all issued tier 2 bonds, with Westpac and ANZ choosing the USD market, leaving NAB in the local market. All issues were hugely oversubscribed, which meant scaling was savage.
As the portfolios have little spare capital, allocations were likely to be immaterial and without the ability to bid for more than I wanted, I had to pass. They have rallied since then, mainly along with outright rates, so this was an opportunity missed due to capital constraints.
However, we did take advantage of some supply in other areas.
Liberty 2018-4 D notes, with an investment grade rating, were bought as a replacement for Bendigo 2023c tier 2 subordinated bonds. This added approximately 1.6% in margin for an equally rated floating rate exposure. Property markets look to be on the improve since the election and APRA’s relaxing of the lending standards make us more confident in these mortgage exposures.
In the Balanced and High Yield portfolios, we took advantage of the new issue from WorkPac, paying 1M BBSY +5.20%. We switched from the lower yielding and higher priced Centuria bonds, with the High Yield portfolio having to use some cash and also sell some Pioneer bonds to meet the $50,000 minimum parcel size.
Both of these trades are classic bond portfolio management – looking to optimise each position when supply allows, not shooting for the stars, but carefully increasing yield without increasing risk, or de-risking and maintaining yield.
Performance has been strong, both from the falling yields and the AUDUSD exchange rate. The High Yield portfolio jumped to a huge 11.35% p.a. return since 1 July 2018, despite being 40% investment grade. This reminds us that even though this portfolio is designed to maximise yield, it still has a core mandate of preserving capital.
The Balanced portfolio also ticked up strongly, achieving 8.8% p.a., up from the prior year’s performance of 7.96%, and finally, the Conservative portfolio benefitted exclusively from the falling yields, just ticking over the 8.5% p.a. threshold. This portfolio only received 1 coupon in the month (and a small one at that), so the performance is all the better knowing that.
We continue to think that yields have a way to fall, so currently we are comfortable with the longer dated exposures. This may turn if economic data begins to improve, but looking at the global picture I am not optimistic.