The Reserve Bank of Australia (RBA) began raising interest rates for the first time since November 2010 on Tuesday of this week, which marks the end of a remarkable period of declining and ultimately low interest rates.
Currently the market expects the equivalent of ten 0.25% rate rises this year and another six or so to follow in 2023, before actually cutting rates again in 2024.
I, along with everyone else, have no idea if this path will be the one we end up following, but the beauty of a well-constructed bond portfolio is that you do not have to care too much about the path and direction of rate rises.
A mix of fixed rate, floating rate and inflation linked bonds with a regular maturity schedule and a reasonable tenor should deliver a stable capital level and a secure regular income, which is what we look to deliver with these portfolios.
This portfolio is all investment grade and all AUD.
The current portfolio yields 4.87% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
This month we added the new bond issued recently by the CBA. A Tier 2 subordinated bond, this ranks one notch higher in the capital structure than the AT1 we had in the portfolio from NAB, with a two notch higher credit rating to boot.
Given the yield to the first call, which is 2-years shorter than NAB, being only 0.30% lower, we decided that this was superior relative value. Another reason is that Tier 2 bonds pay all of their return in cash on the coupon dates, whereas AT1’s pay 30% in franking, redeemable via a tax return. Not a huge difference but we do like to be paid in full and as early as possible wherever we can!
The Balanced portfolio adds higher yielding bonds to the base Conservative portfolio to achieve a higher yield, while 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 38% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 5.69% and is an approximate $600k spend.
We make the same change as above, switching the CBA tier 2 bond for the NAB AT1. Otherwise, we are very happy with the makeup of the portfolio and the extra yield generated by the smaller but higher yielding positions.
The portfolio remains more exposed to variable rates (57% of the portfolio) with floating and CPI linked bonds which is good as the rate hike cycle is underway and inflation is rising.
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 18 bonds, yields 7.75% and is an approximate $550k spend, demonstrating the concept of greater diversity in higher risk positions.
The other notable new issue this month was the Mineral Resources 8% 2027 senior unsecured USD bond. Going for a larger deal meant pricing remained wide of expectations and we were very pleased to see the bond issue with a coupon of 8%.
With a market cap of approx. $11bn and a positive future in lithium to add to existing iron ore operations, we like the credit and with this yield for a short term we wanted to include it in the portfolio.
However, we also like every other bond and as they cheapened over the month, we decided to add rather than replace.
This further diversifies the portfolio which in high yield is a good thing as no one single exposure makes up a significant part of the portfolio.
To view and download our Sample Portfolios, please click here.