We have seen a topsy turvy kind of market since the last update at the end of October. The 9th of October saw the all time low on the government 10 year yield at 0.88%. The 31st of December saw the recent high (highest since the 17th of July) at 1.37%.
Ordinarily a 50bps move in the benchmark government yield, particularly in such a short timespan, would cause huge ructions in lots of markets. Instead, things progressed in a relatively orderly fashion as equity and credit markets strolled towards new all-time highs (equities) and post-GFC lows (credit spreads).
Despite a still weakening domestic outlook, the AUDUSD exchange rate has remained stubbornly in its 0.68-0.70 range, and finished the year at the top of that range.
Neither of these moves were good for the portfolio positioning, but some strong price moves in individual holdings maintained the portfolio performance at a very healthy 7.19% p.a. since inception (29th August 2017).
This means that value is hard to find, and often the optimal strategy is to collect your coupons, review your positioning and make sure you are alert to any new opportunities, as they are few and far between.
I also continue to believe that this cycle of expansion is getting long in the tooth and as such I am cautious in the credit risk I am taking. I do not want to be caught chasing yield and then suffer a capital loss which takes away all the good work of the last two years.
Bearing this in mind, I sought to reduce some of the higher credit risk positions in the period. This will reduce the forward yield further beneath the target 5%, but in this environment, I believe that this is a smart move, as chasing yields ever lower/risk ever higher is not likely to end well.
I decided to sell the Rackspace holding, after a good recovery from its December 2018 lows at around $78 and move into the newly available bond issued by EQM Midstream Partners. Despite its ups and downs, over the two-and-a-bit years I have held Rackspace, it has delivered a 9.6% return p.a., helped a little by the currency moving in my favour over that time.
Rated just above a default rating by Moody’s, moving to EQM considerably improves the credit quality of the holding, even though I am nominally giving up nearly 3% in yield.
EQM is a ‘crossover’ credit, which means it has an investment grade rating from one agency (S&P) and a sub-investment grade rating from the other (Moody’s). At an entry yield of 6.40% this is pricing like a bond which is about to default rather than a company with a US$5bn market capitalisation and secure long term contracted revenues.
Equivalently rated bonds are trading at yields around 3.5%, so there is room for this bond to perform well in a capital sense when its new project comes on line.
I also sold the Harland Clarke bond just prior to its call in January. Pricing was at the par call price and by selling prior, it eliminates any risk of the call not proceeding. That returned exactly as expected the 6.7% yield to maturity in USD when purchased, but 15% in AUD. Always better to get the cash in the bank when you can!
Despite upsizing the EQM position relative to the Rackspace holding, the portfolio is still sitting on about 3% cash (at a zero assumed return).
I am willing to forego this return for the extra flexibility it affords me with prospective new issues given the strong income return from the portfolio.
Very quietly, since late September, the US Federal Reserve has been increasing its balance sheet again, almost completely reversing the “quantitative tightening” they did over a 2 year period from October 2017. The difference this time is that they are in short term “repo” facilities, not longer dated bonds – so apparently “not” quantitative easing/QE (again).
It looks very much like the world’s markets simply cannot handle anything like normal interest rate policies, and in fact are reliant on huge liquidity injections from central banks.
I suspect when these repo facilities roll off on or around the end of February, the resultant lack of liquidity could damage risk markets, hence the portfolio staying long the high quality long duration bonds.
The next update will be for February month end, so I may be right by then or we may all still be in suspense!
|Return since inception (Aug 2017) p.a ||7.19% |
|Purchase Yield to Maturity ||5.14% |
|Market Yield to Maturity ||4.19% |
|Running Yield ||5.65% |
Earn over 6% pa* with Corporate Bonds.
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