Do I really need to mention what is happening in the world? A land war in Europe – the unthinkable has happened again! The effects are being felt globally with oil well above $100 a barrel, and wheat (Russia is the third largest wheat exporter globally and Ukraine is the sixth) is up 50% since the invasion.
Commodity price rises usually signal higher inflation, which the US (amongst other countries although not really domestically) certainly does not need. The Atlanta Federal Reserve also produces a real-time GDP forecast which currently has Q1 growth at 0.0% - yes, you read that correctly, no growth in the first quarter in the world’s largest economy.
The US Fed is set to raise cash rates six times this year if you believe market pricing, into an economy that is not growing. Stagflation anyone?
Fortunately, domestic conditions are more stable and rising commodity prices, in particular iron ore, coal and gold, are good for our economy, which presumably is why the currency has appreciated to around 0.74 against the USD. This however might lower inflation as imported goods cost less in AUD terms – not conducive to rate rises here…
In short, there is a lot going on. One place to hide out with a positive real yield (i.e., greater than inflation) are these sample portfolios. Take a look at what we think is value for the risk, and let us know if you’d like to make some changes more in line with these.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 3.98% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.
Computershare was good protection against the yield rise in the first months of the year. However now, looking at the belly of the curve (4-7 years), we revert to one of our favourite issuers in Pacific National.
The 5.40% 2027 fixed rate bond trades with a high capital price but the yield to maturity is excellent at 3.64%, which is 0.60% more than the Computershare bond, and so we switched them.
A few months ago, we added floating rate notes to increase our capital stability and capture extra yield with the possibility of rising rates. The curve has steepened a lot since then, making these floaters look very attractive on a yield to maturity/call basis but for balance, remember that there are over eight rate hikes priced into the next couple of years. With the risk factors noted above, these may not eventuate, which is why we keep some duration (longer dated fixed rate bonds) in the portfolio.
Balanced portfolio:
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 4.91% and is an approximate $610k spend.
As mid to longer market yields have risen somewhat in the face of inflationary worries, subordinated bonds have also reduced somewhat in price, making their yields more attractive. A case in point here is the Société Générale 2024c AT1, which with the risk-off tone of the last few weeks has cheapened considerably.
In the last couple of months, we slightly altered the composition of the investment grade portion of the portfolio, moving the allocation slightly more to high yield with the introduction of this, amongst other, bonds. Therefore, we do not make the changes per the Conservative portfolio as we didn’t include those bonds in this portfolio.
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 7.00% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
The only new issue in the period was the tap of the Zagga bond issued in November, which is already in the portfolio, so we had no new bonds to include.
Some of the USD bonds in particular look very enticing, with yields approaching (if not outstripping) 7.00%.
As a result, we took out the Emeco July 2026 bond denominated in AUD, yielding 5.79% to a 2026 maturity with a B+ rating for a secured position and replaced it with the subordinated AT1 bond from ING Group. The ING Group AT1 bond has a slightly longer May 2027 first call date, and is a callable subordinated bond rather than senior secured.
Yielding 6.33% to the first call, this fits our long held thematic of coming lower in the structure in large, well-capitalised businesses to enhance yield rather than taking higher credit risk. With the AUDUSD rate climbing post the invasion of Ukraine, we see this as a good entry point as no doubt the commodity price rises will ameliorate at some stage, and all things being otherwise equal, we see the US raising rates more than domestically, which should weaken the local currency.To view and download our Sample Portfolios, please click here.