What a short time a month is in markets. I am writing this on Monday 2nd and it might be out of date before we publish on Thursday 5th!
After last month’s rapid sell off, this month we have seen an almost total reversal as the reality of the gargantuan capex spending on AI has come home to roost for the tech companies.
Last Friday Intel, which isn’t even one of the big spenders, became the biggest casualty, announcing margin guidance well below expectations. The stock had its worst day ever, down 28%.
This followed Meta and Amazon announcing hundreds of billions of AI spending which saw them both sell off ~6-8%. Microsoft got away with it as they had good profits an announced “only” $200bn of spending vs the other two’s ~$600-800bn (each!).
The gulf has been a sideshow for the month as we approach the US midterm elections, but if the rumour mill is correct, we will likely see a significant escalation once they are out of the way, which will have happened by the time this goes to print.
The RBA is due to raise rates tomorrow for the fifth time this year. Cracks are starting to appear, particularly in property markets as this and the tax changes announced in the budget start to bite.
There is so much going on….
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.79% and consists of ten bonds of roughly equal weight by value to total an approximate $515k spend.
Despite the strong rally in government yields in the month, the main effect has been felt at the long end of the curve. The duration of this portfolio is relatively short, at 3.5 years, so the valuation hasn’t been overly affected.
Credit spreads have widened modestly, acting as a counterbalance as they usually do. This has impacted the two French banks in the portfolio the most given their sovereign issues spilling over to this sector, but for now we are comfortable retaining their exposure.
It is comforting that despite all the uncertainty in the world this portfolio is behaving exactly as you would expect it to.
For new issues in the month, the only one that came close to inclusion was a new hybrid from the largest Japanese bank MUFG. The yield was attractive, over 7%, but with a split rating of one above and one below investment grade, we felt we should not include it in this investment grade only portfolio. Besides, the yield was lower than the equivalent UBS bond, so we stayed with the higher yield.
Boral finally issued their long-awaited new bond, but it also didn’t make the cut in yield terms.
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 41% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 7.39% and is an approximate $600k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
With the widening in spreads during the month, the yield differential between this portfolio and the Conservative widened from 0.50% to 0.60%.
We like the insurance hybrids and have the Suncorp 2032c in the portfolio. However, for a reason unknow to us, the equivalent QBE bond is yielding ~20bps more, so we switched that one in for the Suncorp.
This highlights our fundamental premise – that we can identify when the market prices risk inefficiently and so we can take advantage to provide better risk-adjusted yields.
The remainder of the portfolio stayed the same as the new IG issues didn’t make it in as in the Conservative portfolio, and there was no high yield issuance in the month that interested us.
We are unlikely to include ABS/RMBS until spreads widen to a level where we feel we are being properly compensated for the risk. So far with the property correction these spreads have been well behaved, but if unemployment, which is the true risk behind RMBS, spikes, we will be taking a much closer look.
High-Yield portfolio:
The High Yield portfolio looks to generate a higher 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 15 bonds, yields 7.90% and is an approximate $450k spend, demonstrating the concept of greater diversity in higher risk positions.
The good news about the new MUFG hybrid being rated sub-investment grade by S&P means that it immediately caught our eye for this portfolio.
With the takeover of Clearview by Allianz and the subsequent repricing to a new investment grade risk level, we have been waiting patiently for a new bond to allow us to switch this out, and we have finally found it.
Whilst the MUFG is fixed, it is still relatively short. Part of investing in high yield is dealing with the dearth of floating rate notes, so another fixed rate bond is just another to add to the pile.
The higher coupons make this portfolio shorter duration anyway – currently just 3 years - so removing a floater for more fixed doesn’t really move the dial.
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