A month is a long time in markets, and it’s been at least that long since we updated the portfolios. It’s also been the summer holidays domestically which means a quiet time, and this has definitely been the case apart from one spike of activity around the new Santander bond.
In the run-up to Christmas, interest rates fell quite a long way as the end of the hiking cycle got some investors excited. Since then, the story has been a reversion of this excitement as some of the cuts began to be priced out again and yields rose.
A couple of months ago investment grade bonds were pricing at 7%, and now it is low to mid 6%. Quite apart from the potential for capital price increases, attention is turning to maintaining income for the medium term should rate cuts indeed eventuate. This means longer-term fixed rate bonds are the focus for investors.
Last update we mentioned the WBC 7.199% 2033 bond issued in October. With the rates moves this is now priced around 107.50 area, showing the benefits of duration exposure works.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.73% and consists of ten bonds of roughly equal weight by value to total an approximate $490k spend.
In line with the Research team’s LOCK strategy published in their Outlook for 2024, we are increasing the duration of the portfolio further as well as optimising the yield as normal.
The recently issued Santander 6.499% 2031 senior non-preferred bond, rated A-, looks like the best value fixed rate bond in the market. We also like the WBC 7.199% 2033 rated BBB+ and the BPCE 7.6237% 2033 also rated BBB+. Given their high coupons, both of these trade with high capital prices but still yield over 6%, which is getting pretty rare in the investment grade fixed rate universe.
Looking at these 3 bonds, we decided to switch out the Lloyds 7.086% 2028 bond which offers only 5.47% at current prices, as well as 2 floating rate bonds in the BNP BBSW +1.55% 2026 and AMP Limited BBSW +3.15% 2026.
Both of these floating rate bonds offer margins lower than 2.00%, and even though the WBC and BPCE bonds have high capital prices, they also have high coupons which improves the income yield of the portfolio.
In the absence of new fixed rate issues, these still look like good value additions to the portfolio.
These changes increase the yield of the portfolio by 0.10%, which given the large fall in yields since the last update is welcome, as well as maintain the income yield, increase the duration to 4.65 and also improve the average rating to A from A-.
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 6.98% and is an approximate $600k spend.
This portfolio, by virtue of the high-yielding allocation, has a much shorter duration than the Conservative.
Having made a floating for fixed switch in this portfolio last month, changing the BNP 2026 floating bond, we were left with the AMP bond per the Conservative portfolio as above. We therefore switched this out for the Santander 2031 fixed rate bond.
The duration of this portfolio is longer again than the prior update at 3.25, but still shorter than the Conservative portfolio due to the high yield portion.
The yield we get from this part of the portfolio means that we did not need to bring in the higher capital price bonds as above.
Income remains strong at 6.50%, and this portfolio is very well set up for whatever 2024 may throw at it.
High Yield portfolio:
The High Yield portfolio looks to generate a higher yield while still looking to have a bias toward as low-risk positions as possible.
This is achieved by good diversification and attempting to identify fundamentally mispriced bonds.
The current portfolio has 14 bonds, yields 9.59% and is an approximate $458k spend, demonstrating the concept of greater diversity in higher-risk positions.
With the decline in yields, some of the USD-denominated bonds with investment-grade ratings are no longer high yield. Allied to the level of the currency it is time to take these out of the portfolio.
Strong yields are available in BB-rated RMBS at the moment, so we will add one of these which is currently available while we look for others as the primary market starts up again after the break.
To this end, we remove the following USD bonds: Edison 2026c, WBC 2027c, and QBE 2025c, all of which are under 7% yields.
We will add the Liberty 2022-2 E note, which is rated BB and offers a margin of nearly +5.00% for a forecast yield of 9%. Much more like a true high-yield bond.
This reduces the cash spend on this portfolio to a touch over $425,000, so we will be looking for new bonds to add to bring it back closer to $500,000.
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