The end of March saw calm return to bond markets after the large rise in government yields through much of February and the early part of the month.
Many central bank speakers from both the US Federal Reserve and the RBA were at great pains to hose down optimism about the post COVID recovery by pointing out the significant slack still existing in employment markets in particular despite positive headline numbers, and remained committed to their very accommodative policies.
The likely main theme of the year will be the push and pull between these central bank doves and the reflation narrative weaving its way through markets – are we in the calm before the storm?
Certainly, as equities hit ever loftier all-time highs and post COVID targets the likelihood of a correction seems to grow, and with credit spreads back to pre COVID tights there is also a little coiling of a pressure spring in the bond markets.
The rising yields we have seen have made our sample portfolios more attractive, with the Conservative portfolio in particular popping up back over that 3% threshold, up around 0.20% from the prior month.
This portfolio is all investment grade and all AUD.
The current portfolio yields 3.15% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.
We made three changes to the portfolio this month. With the new issue market becoming more active, we had new bonds to choose from.
We decided to rotate the infrastructure sector a little and replaced the Brisbane Airport 2030 bond with the newly issued WestConnex 2031 senior secured bond. BrisAir as it is known had a great run and whilst still offering an attractive yield, we noted we had 2 airport exposures, so reduced this subsector by adding the motorway network.
With Transurban a larger shareholder, we expect over time this bond to trade towards the Transurban spread which will hopefully result in an uptick in price of $3-4, all other things being equal. We felt this opportunity was exhausted with the BrisAir bond.
Lendlease also issued a 10-year green bond at an attractive margin. Their previous 7-year green issuance had performed very strongly with the green bid and good pricing. It proved so again, and a slightly smaller than expected issue size coupled with huge demand has seen this perform well, and yet still offer strong relative value.
In the RMBS space we decided to upgrade our BBB rated exposure to the inaugural issue from Defence Bank, the Salute 2021-1 D notes. With a longer expected weighted average life than usually seen due to the low level of refinancing by current and former defence staff, yet with a lot of support provided to the mortgage pool by their conservative nature and government support, this bond looked attractive. RMBS remain one of our top value picks, particularly in the BBB rated D notes and BB rated E notes (for high yield investors – see below).
While the individual bonds shown in these portfolios may not be replicated exactly with upcoming issuance, typically the ratings are calibrated to deliver a similar risk level and return depending on the variations in the underlying pool of mortgages, so similarly rated bonds from different deals can easily be substituted for those shown here.
The Balanced portfolio adds higher yielding bonds to the base Conservative portfolio to achieve a higher yield, while still maintaining a balance between risk and return, skewed towards preserving capital rather than chasing yield.
It aims to have between 15-20 positions, with the high yielding bonds in smaller parcel sizes (comprising 24% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 3.86% and is an approximate $600k spend.
We made the changes above to the Investment Grade portion of the portfolio.
As mentioned, we like the BB rated E notes in RMBS transactions at spreads greater than 5.00% over the BBSW rate, and as such we added the recently issued REDZED 2021-1 E notes in place of the Sunland bond.
As highlighted last month, Sunland are winding down their business and as the call date approaches, the yield reduces accordingly. Given the support shown to both employment and the property sector by both the Government and the RBA, allied to the inherent robust structure in place in RMBS transactions to protect investors, we are comfortable adding these junior notes to look to increase yield.
High Yield portfolio:
The High Yield portfolio looks to generate a high yield while still looking to have a bias towards as low risk positions as possible.
This is achieved by good diversification and attempting to identify fundamentally mispriced bonds.
The current portfolio has 16 bonds, yields 5.43% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
Following on with the BB rated RMBS concept from above, we added the REDZED bond in place of Sunland and also the Liberty 2021-1 E notes, which we switched in for the OMNI 2026 bond.
As one of the strongest unrated credits in the FIIG originated stable, the yield on this bond has been creeping ever lower, and we felt we could increase yield in the RMBS without materially increasing the risk – a constant goal for all portfolios but particularly for the High Yield portfolio when individual bonds reach the low 4% area.
We also brought back the ElanorWild 2024 bond into the portfolio, in place of the GEO Group 2023 USD bond.
Whilst we still do not fully understand the practicality behind the US Executive order to cease renewal of the contracts with private prison operators, we acknowledge that GEO is likely to be under a large amount of headline pressure for the foreseeable future.
Given the price on the bond has currently held up, we feel a better skew of risk/reward can be attained in ElanorWild, especially given the recent price recovery and the equity-funded purchase of another Wildlife Park, adding to the secured asset base and profits supporting the bond.
Other USD bonds we like:
The table below continues to show other USD bonds we like that don’t fit the parameters of this particular portfolio.
All of these bonds have become cheaper since the February update.
To view and download our Sample Portfolios, please click here.