Apart from the ongoing human tragedy in Ukraine, the story of the last month has been the will they/won’t they hike in cash rates. The US Federal Reserve took the first of no doubt many steps this year and raised rates by 0.25% - not much when inflation is nearly 8% you might think, but they are poised for a lot more.
In sympathy, even though our most recent inflation number was a mere 3.5%, our bond yields have risen by 0.60-0.70% out to 10 years as domestically the market has clearly decided we will follow the US path.
Interestingly though markets forecast 10-year inflation break even points are still around the mid 2% levels – so a bit of offsetting information there, which seems a sign of the times – uncertainty seems the only certainty…
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 4.60% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.
With half the portfolio already in floating rate bonds and a further 21.5% in inflation linked bonds, to protect us from rising yields and/or inflation, we have resisted the urge to go all in on these variable rate bonds just in case the market turns out to be wrong.
Last month we added back our best value issuer in Pacific National for a fixed 2027 maturity, and we make no changes this month.
With yields nearly 1% higher on the month the portfolio now looks even better value than it did in March, with the headline yield well over 4.50%.
Given the excellent track record of investment grade bonds in Australia this yield looks very compelling versus other alternatives available in the market.
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 5.38% and is an approximate $600k spend.
Demand has driven the price of the Société Générale bonds back towards par, but we still think they look very attractive for their short tenor, showing how short dated fixed rate bonds can be attractive even in a rising rate environment. Being a fixed coupon they lock in future expected rate hikes even if they do not eventuate, yet minimise risk to the capital price by being so short and therefore close to par.
With no new issues of note relevant to this portfolio, we are just enjoying the higher returns the market is currently offering us and make no changes this month.
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 7.26% and is an approximate $525k spend, demonstrating the concept of greater diversity in higher risk positions.
CEFT tapped its existing bond in March at a higher yield than at issue, recognising the lift in rates since the initial primary in November. At a yield of 6.52% this looks attractive for a 2½ year exposure – see the comment about short, fixed rate bonds above.
The Macquarie 2027c USD AT1 capital instrument is a very solid name no doubt familiar to all. The price has improved a touch during the month but at a yield in the mid 5% range still looks attractive to us, so we added it to the portfolio this month. Whilst we do not look to play the foreign exchange game given the unpredictability, with the AUD-USD rate around 0.75, adding USD exposure is attractive here as well.
In an eventful month for Nickel Mines, their offtake counterparty and partner in many of their mines got caught in an epic short squeeze on the nickel market, resulting in its closure for over a week. This put pressure on the bond price (which has since recovered somewhat) but we believe the company is still fundamentally sound and looks attractive at a yield above 8% to the 2024 maturity.
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