It’s been a challenging few months in the markets to say the least and these irregular but severe shocks often remind investors to review their investment portfolios. Although prices have been volatile during this time I think it’s important to remember the fundamentals of bonds - that is their obligations to pay coupons and repay capital at maturity. At any given time interesting opportunities may arise, however always consider these with your investment goals in mind and make sure to regularly review your portfolio as a whole.
The reporting that FIIG provides for clients through the Portfolio Performance Reports makes it easy to see a snapshot of your portfolio and monitor the aspects you want to manage. These reports can be downloaded from the MYFIIG portal under the documents tab.
Some of the important aspects of a portfolio worth reviewing and monitoring are outlined below:
Being diversified across different issuers can help to protect your portfolio if one of your bond issuers is going through a difficult time. However, it is a bit like the Goldilocks story (you don’t want too many or too little bonds).
Where is “just right”? Somewhere between 10-20 names is a good number. Most clients identify with a strategy of investing greater amounts in investment grade bonds. Then for those wanting to add higher risk exposures should consider investing smaller allocations to a wider variety of names. This allows the portfolio to generate higher returns without taking on a proportionally higher level of risk.
In normal market conditions looking at the Annualised Returns and the Yield to Maturity (YTM) helps to gauge your overall return since you have held the bond and determine the yield left until the bond matures. You should also keep an eye on the Yield to Worst (YTW) which indicates the lowest possible yield, taking into account the potential exercise of an issuer redemption option at a point which is sub-optimal for investors.
If you’ve had a higher than expected annualised return, then the YTM from now until maturity will be lower than expected at the point of purchase. In such a scenario, some clients may choose to take profits and move into other bonds that are expected to provide a better yield.
Conversely, some bond prices may have traded down, implying a potential loss which would only be crystallised if the position is sold. If you’re comfortable with the credit and its ability to survive to maturity, holding, collecting income and waiting for prices to recover is generally the best course of action.
If you are considering trading some of your bonds there are obviously other considerations including reinvestment options, and if the new bond will provide similar portfolio exposure. For example, replacing an investment grade bond for an unrated bond with a higher risk profile would need to be considered carefully, with a particular focus on the overall balance of your portfolio.
Another aspect to consider is if there are any bonds that have underperformed and the reasons behind the poor performance. If you are no longer happy with the credit of a company then it’s a good idea to find a substitute bond.
The three types of bonds (fixed rate, floating rate and inflation linked) will perform differently under various market scenarios. Having a range of bonds will help create a portfolio that should provide less volatile returns in different interest rate environments. Our Investment Strategy team recommends an equal allocation split between fixed, floating and inflation linked as a starting point, however depending on value and availability, or if you have a certain view of the economy, then the allocation can be adjusted accordingly.
For example, if you think interest rates are going to go up, you can increase the allocation to floating rate notes. In today’s current environment where BBSW is c. 0.10% and the outlook for interest rates to rise is a distant prospect the difference between the fixed and floating isn’t as important.
Just like a company wouldn’t want to pay back all of its debt at the same time, generally investors wouldn’t want all of their bonds maturing at the same time. We recommend trying to spread maturity dates over different years.
This means you have liquidity at various points in the future should you need the funds and are less reliant on the secondary market. Bonds that have matured in the past few months have given investors the chance to take advantage of some interesting opportunities or given investors access to cash without having to sell at unattractive prices.
Another factor to consider is do you have any bonds due to mature in the next year? In times like this assessing a company’s ability to refinance is also an important consideration.
Just like you don’t want to be overweight to a particular issuer, neither do you want to be overweight a particular industry. It is worth checking industry concentration, not just for your fixed income portfolio, but also for your deposits, shares and hybrids. Many Australian investors are overweight banks and financials.
If a particular industry goes through a hard patch, a portfolio diversified by industry won’t take as big of a hit. This is another segment that can reflect your views on the market. If you think a particular sector is going to perform well then you may want to consider a higher allocation to that sector.
Your relationship manager will be here to help you review your portfolio on a regular basis, some clients like to do this annually and others more frequently.