Over the month of April we have seen the situation in the Gulf meander towards a stalemate. Oil prices, rather than spike up and down on escalation/de-escalation events, have slowly ground higher.
The market narrative is now about how long these higher prices, and their second order effects feeding into inflation, will last and how large these effects will end up being.
We had an insight into Australia’s exposure with the quarterly CPI numbers issued on the 29th of April showing a huge increase in headline CPI (which includes petrol) to 4.6% year-on-year. The policy-important trimmed mean was also much higher than the RBA target at 3.3%.
The RBA has raised rates for the third time in succession to attempt to get a handle on inflation, but arguably the most important factor in domestic inflation is government spending, which we hope will be at least somewhat reined in when the budget is announced on Tuesday the 12th May.
The calmer periods allowed for the primary market to continue apace, with several new bonds being issued that we liked and include in the portfolios.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.27% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
Plenty of good bonds to choose form in the new issue market this month. Yields were a touch lower in the market but with the new bonds we maintained the portfolio yield.
The ones that made the grade in the more conservative end of the market were new subordinated bonds from gas infrastructure business APA and a rare OTC hybrid from now pure-play insurance company Suncorp.
APA issued senior and subordinated fixed and floating tranches simultaneously in a three-part deal. We preferred the subordinated options given the very stable nature of APA’s business and also, after a long period of strong fixed rate issuance, the floating option. We switched out the AMP sub for a ratings and yield pickup.
The Suncorp was a welcome surprise and priced a small deal aggressively into a pretty large order book. Pricing ended up at a margin of +235 fully franked, another fairly rare feature of this new bond. We switched out the Ausnet hybrid, again for a ratings and yield pickup.
By extending tenor in floating rate bonds, it enables the portfolio to pick up margin without the duration risk that comes with fixed rate bonds. If credit spreads do widen it does expose the bonds there, but with corporate earnings doing well we see credit risk as the lower risk option currently when compared to duration (interest rate) risk.
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 31% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 6.90% and is an approximate $600k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
We made the two above switches for the investment grade portion of the portfolio.
The other key new issue of the month was Next DC finally coming to market with their long promised subordinated bond.
Demand was also very strong for this one, and they opted for a smaller issue size at keener pricing than a jumbo deal. Even so the issue size of $750m was significant for an unrated credit, albeit one with a ~$9bn market cap.
The timing is particularly nice as RACE have just asked for a consent to adjust their call dates to allow early repayment. Whilst this is still open and so undetermined, we take the opportunity (assuming they will repay in the next month) to switch this out and add the Next DC. This adds yield and although both are unrated, in our opinion there is no doubt that Next DC is a better credit risk than RACE.
Next DC was supposed to replace Thera, but with the RACE situation we needed to bring in another new bond. The Stonepeak listed bond has been in the portfolio before and now we reintroduce it with a strong forward yield and more floating exposure.
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 14 bonds, yields 7.22% and is an approximate $410k spend, demonstrating the concept of greater diversity in higher risk positions (see below).
Next DC finally issued the subordinated bond that had been on the radar for a while, and at attractive pricing, which we included in the portfolio.
With Peet and Thera redeeming and RACE looking to redeem and as such removed from the portfolio, we will need another new bond or two to add to the portfolio in due course as the portfolio is down to 14 bonds and the yield is temporarily lower than we would like.
We have a number of bonds with investment grade ratings that were previously high yield such as both the NWG bonds but those are getting shorter and lower yielding. The USD curve being materially lower than the AUD curve doesn’t help finding suitable risk/reward balances for yields that justify the foreign exchange risk.
It is a tricky spot for high yield at the moment!
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