Tuesday 15 May 2018 by Guest Contributor Opinion

Moving to higher ground

The end of the credit cycle may soon be upon us. Director Fixed Income Sales, Michael Cooper urges investors to revise their bond portfolio; is it fit to survive an economic downturn, or perhaps it’s time to adjust your portfolio while there’s still time?


As we move deeper into one of the longest credit cycles in recent history, the probability of coming to the end of the cycle increases. Typically, the end of cycle is accompanied by financial market dislocation, which for high yield bonds in particular almost always results in higher interest rates and lower bond prices. Given corporates generally are running higher levels of gearing than historical averages, there is a risk that defaults could be even higher.

The beautiful thing about bond investing is that if we remain confident about the ongoing survivability of the issuer, while the price of a bond might rise and fall due to changing credit worthiness or general levels of risk, a bond will deliver its legally obliged coupon payments and redeem at par ($100). As investors, we will walk away with coupon payments and capital.  However, depending on the credit profile, the price journey to maturity might be a volatile one.

A balanced corporate bond portfolio from a credit perspective is typically made up of 60%-70% investment grade bonds and a diversified holding of sub-investment grade or unrated bonds for the remainder. This is a portfolio not as conservative as say one made up of 100% government bonds, however it is a portfolio that should serve investors well, deliver a relatively attractive return compared to cash and largely protect capital in a crisis. 

Portfolios running higher allocations to high yield bonds require a higher level of oversight, a willingness to act without hesitation when required, and acceptance of significantly lower bond prices and likely illiquidity during times of market crisis. These portfolios are designed for higher yields now. In contrast, 100% investment grade portfolios with a significant allocation to highly rated bonds provide investors the chance to sell and move to cheap investments during a crisis, such as very cheap shares, property or high yield bonds. In return for the additional risk and associated emotional rollercoaster, investors enjoy higher levels of income and return than more conservatively positioned portfolios.

USD denominated bond allocation and credit profile is very relevant to portfolio considerations. USD denominated bonds have historically offered AUD denominated investors a wealth hedge in almost all of the more recent market crises. While the currency and the credit can both move in a negative fashion, a ‘risk off’ market would see investors sell high yield in any currency and buy USD Treasuries, pushing up the USD exchange rate.

One scenario that would be a disaster for AUD investors who own USD investments, would be a crisis accompanied with a flight to quality AWAY from the USD. A low probability, nevertheless still a possibility!

The point of all of the above is that given the emerging risk, it is important to consider whether your bond portfolio is ‘fit’ for purpose?  Is it structured to achieve what you intended it to achieve? How would you feel if your high yield bonds all fell 15% lower in price?  Have you too much USD denominated bond exposure or maybe too little?

For years, many investors have enjoyed the higher income levels delivered by higher portfolio allocations to high yield bonds. No one knows when the next crisis may arrive but it will. The indicators I watch are not telling me that we have an event looming, it’s more that conditions feel ‘ripe’.

I’ve said many times that for me, the art of investing is to manage risk first and the upside will look after itself. It’s time now to consider your overall bond portfolio risk profile.  If it’s not ‘fit’ for your purpose then we need to make a plan while we have the time.

Below are some investment grade bonds you may like to consider. 

Issuer Rating Maturity date Coupon rate Type Yield to worst* 
Liberty Financial Pty Ltd BBB- 1-Jun-20 5.10% Fixed 4.35%pa
Insurance Australia Group BBB 15-Jun-24 2.10%  Floating 4.30%pa 
Asciano Finance Ltd BBB- 19-May-25 5.25%  Fixed  4.27% 
RMBS Investment grade      Floating   

*Prices are accurate as of 14 May 2018, subject to change
Note: All bonds available to wholesale investors only

USD investment grade bonds

Issuer Rating Maturity date Coupon rate  Type Yield to worst* 
QBE Insurance Group Ltd BBB- 17-Jun-26 5.88% Fixed 5.39%pa
Vale Overseas Limited BBB- 10-Aug-26 6.25% Fixed 4.58%pa
Newcrest Finance Pty Ltd BBB- 1-Oct-22 4.20% Fixed 4.01%pa
CIMIC Finance USA Pty Ltd BBB- 13-Nov-22 5.95% Fixed  4.21%pa

Note: Prices quoted are accurate as at 14 May 2018, but subject to change
USD bonds are available to wholesale investors only
Minimum QBE investment is USD200,000

For more information, please call your local dealer.