March has been dominated by global headlines about US tariffs and their effects on global trade.
At the time of writing, “Liberation Day” is tomorrow’s problem, so we will see how markets react over the next couple of weeks.
Equities certainly haven’t liked the uncertainty, finishing the first quarter well off the start of year levels. Government bonds typically perform well in these risk off periods, although this time actually is different, given tariffs have historically
been inflationary which has kept bond yields more elevated than might be expected.
None the less in the last week in particular we have seen risk free bond yields fall by up to 20bps, albeit from levels pre-Christmas that were higher given the markets’ expectation of a Trump presidency which is now coming to pass.
Credit spreads have also widened somewhat, again about 15-20bps, although this seems to have been the result of new issue indigestion, with many coming to market in the month, and indeed, one, from ASX-listed Worley, not even making it that far due to
“uncertain market conditions” – read for that a wider spread than desired.
Edit post tariff announcement: Well, that went about as badly as could be expected! Large equity losses and unexpectedly rising US government bond yields at the long end as the market tries to digest the uncertainty.
This will play out over coming weeks/months and we will try our best to keep you updated…
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.61% and consists of ten bonds of roughly equal weight by value to total an approximate $520k spend.
As a reminder, the portfolio contains a government bond with a low yield. This is not expected to be held to maturity but instead traded if and when yields fall. Therefore, the portfolio yield is understated compared to expectations given it is unlikely
this low yield to maturity will be realised on these bonds.
Additionally, the inflation linked bonds have an assumed 2.5% inflation rate in their yields. With inflation having been high and now stubbornly refusing to come down, these bonds may also return more than currently forecast.
Last month there were 3 new issues in a week, from Coles, AGN and Scentre. As mentioned above, Worley were also due to issue but withdrew.
Whilst there was lots of choice, we are as always picky about what we include. The only bond to make it into the portfolio was the Scentre. They issued fixed and floating rate, and currently the fixed rate bond offers ~20bps better yield than the floater
and also more than the HSBC from last month, so we switched that in.
Further benefits are slightly increased duration and continued diversification away from the financials sector as more genuine corporates issue attractive bonds. We have nothing against banks and insurers – indeed, they are large, stable companies
which we like – but we just see better value in corporates at the moment.
With the fall in yields mentioned above, the 2033 government bond has a headline yield in the 3s. Ordinarily we wouldn’t include such a low yielding bond even in the Conservative portfolio, but if the tariffs for example do indeed cause a global
slowdown, these bonds will perform very well indeed and multiples of that 3% yield will be realised
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 27% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 6.15% and is an approximate $630k spend.
This portfolio, by virtue of the high yielding allocation, has a much shorter duration than the Conservative.
Given changes in capital value, we readjusted the investment grade bonds to be an approximate $50k spend per bond.
Because of this shorter duration, we decided to sacrifice a floating rate note for the new Scentre fixed rate bond. The Liberty 2023-1 E note has been upgraded multiple times since issue and is now at A1 (A+ equivalent). This is too high a rating for
the yield we are seeking, so this is the casualty.
This also increases the duration, which improves our exposure to lower rates, although we are still relatively short at 3.86.
Clearview issued a new high yield subordinated bond in the month, which can still be bought for ~7%. With the lowest yield of the unrated bonds, Zagga was switched out for this new bond.
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 17 bonds, yields 7.15% and is an approximate $540k spend, demonstrating the concept of greater diversity in higher risk positions.
As spreads have widened this month, the sensitivity of this portfolio, being very credit-heavy, has meant yields have risen when compared to last month, the opposite to the other two more conservative portfolios.
We also replaced the Zagga bond with the new Clearview issue.
The Barclays curve remains very flat so we looked at the extender to the newer bond again but the yield pickup still was not considered enough to make the switch.
To view and download our Sample Portfolios, please click here.