May was largely a big nothing burger in wider markets. The Iran war has ground to a ceasefire punctuated by attacks and retaliations that apparently aren’t a breach of said ceasefire and now we await the details of a deal that is, very optimistically, supposed to deliver an open and un-tolled Strait of Hormuz and no nuclear material remaining in Iran.
This optimism has seen oil move lower after last month’s grind higher, and as a result equities and bonds have both moved higher, with Australian bond yields between 25 and 20 basis points (bps) lower across the curve over the month.
The April monthly CPI no doubt helped with that as it came in 0.2% under expectations, but still high at 4.2%, with the policy-relevant trimmed mean at 3.4%. This will no doubt help the Reserve Bank of Australia (RBA) keep rates on hold but as the Gulf-related products reach the end of their stored supplies and supply restrictions really do bite, we will see if prices rise again.
In really good news, the primary market was active, so we have new bonds for inclusion in the portfolios.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.31% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
The primary market delivered several new bonds this month which gave us a good range to choose from, as well as keep the yield higher than last month despite the fall in market yields.
In the floating space we have Liberty Financial’s annual 5-year senior bond and the standout option, a new partially franked insurance Additional Tier 1 Capital (AT1) note from QBE, hot on the heels of last month’s similar offering from Suncorp.
The QBE was the best value, being a 7-year with a higher margin and a 6 monthly coupon to line up with dividend payments for the franking, both of which added to the margin available. It priced at 6M BBSW +2.50%, which is a headline yield of 6.75%, well above the shorter and higher rated CBA floater, so we made that switch.
We do have both insurance AT1s in the portfolio so will monitor that sector as we don’t want to be overallocated if something does go wrong, but strong results and a disciplined approach to risk by both give us comfort.
NAB issued a 10-year fixed Tier 2 subordinated bond at an attractive coupon of 6.558% but this was bettered by French bank BPCE which also did a similar structure. We preferred the lower rating and higher coupon of 7.156% in this instance and replaced another French bank in Credit Agricole to pick up about 0.40%. We still like the French banks but as in all things we don’t want to be over exposed and so will limit holdings.
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 6.86% and is an approximate $580k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
This portfolio didn’t own the CBA floater so we could only do the BPCE for Agricole switch mentioned above.
As the new QBE bond is a year longer than the Suncorp, it offers a higher margin and better cashflow, being only partially franked. We therefore did the insurance switch here for this one and picked up about 0.25% in yield.
The key new bond for the sub-investment grade market in the month was a new AT1 from UK bank Barclays. In a bit of a milestone for the local market, they issued $1bn of a BB+ rated bond from an order book of $2.6bn. This is the largest local sub-investment grade deal in history I believe and hopefully paves the way for a lot more.
A 6-year to first call fixed rate bond that priced at a margin of 3.24% over swaps, this has a very attractive 8% coupon and so makes a great addition to the portfolio. To manage the AT1 risk in this riskier portfolio we decided to switch out the BNP AT1 which also diversifies country risk from France to the UK. The one notch lower rating delivers a ~1% pick up in yield.
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 15 bonds, yields 7.29% and is an approximate $440k spend, demonstrating the concept of greater diversity in higher risk positions.
The new Barclays bond allowed us to add another high yielding bond into the portfolio after the last few months of redemptions, with a yield of 7.63%. This helps get the number of bonds higher and improves diversification. We are aware we have another Barclays bond in the portfolio and will continue to monitor that exposure.
In further good news, the most recent of the many ABS deals that have come to market was an SME loan backed portfolio from Judo Bank. Different to the standard mortgage and auto loan deals, this Ba1 rated E tranche offered exceptional relative value with a yield over 8% for a short WAL of 2.6 years.
We are investigating new USD and GBP bonds as more foreign banks have issued AT1 with attractive coupons over 7% and will look at them for next month.
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