The first thing to say is that the last 2 months have really seen the positioning of the portfolio deliver strongly in response to market moves, with the return jumping to 8.9% p.a. since inception. As a reminder, the initial premise was to constantly deliver a 5% yield to maturity with a focus on capital preservation, but to look to position for economic developments.
With 65% of investment grade bonds, and nearly half of that in highly rated government/semi-government bonds, it is certainly a lower risk portfolio, yet is really delivering on the return front.
There has been a lot going on in the portfolio since the last update at the end of June.
The general environment has seen government yields falling sharply in the last 2 months, (by about 0.4%) but credit spreads have remained broadly the same, which has delivered performance to the longer dated credit exposures such as Sydney Airport 2030 and Pacific National 2027, as well as the government bonds themselves.
As a broad statement, an 0.4% decline in yields delivers an approximately 3.2% increase in price on a 10 year bond. This translates to approximately 1.3% for the whole portfolio from those exposures.
At the same time we have seen the AUDUSD exchange rate also falling by nearly 3 cents or 4.3%. With 23% of the portfolio denominated in USD, this has delivered about 1% in performance for the whole portfolio.
The trick in the future will be to try and time the potential turnaround in either yields or credit spreads. Getting this right in practice is almost impossible, and so I will be looking to transition away from long duration when I feel the bottom on yields is close. In my opinion this won’t be for a while, as broad economic indicators are pointing to even lower yields from here.
The subtlety is in the divergence of credit spreads and risk-free yields, when the market determines the economic situation is bad enough that credit spreads will need to widen to reflect the higher risk in lending to corporates. One to watch closely.
Turning to specific trades, I again kept it relatively simple, just looking to pick up strong relative value in new issues.
I sold the NAB subordinated bond, realising a 1% return in just 2 months, and bought the new WorkPac FIIG originated bond. Despite moving from an investment grade credit to unrated, I really like the structuring of the Workpac deal, with high quality counterparties and the added backstop of the receivables insurance from an AA- rated insurer. Worth taking this nominal extra risk for a >3% pick up in yield.
I switched the shorter dated Liberty 2020 fixed rate note for the new 3½ year floating rate note, for a pick-up of approximately 0.40% in margin for a 3 year extension in tenor.
In the high yield portion of the portfolio, I decided to exit Bristow, despite being comfortable in the secured position at the top of the capital structure.
Going through a potentially protracted US Chapter 11 bankruptcy process, with coupons suspended, was not worth it, given the bond had rebounded strongly from its news-driven shock low prices in the mid 70s just a month or two ago. This realised a 10.4% return in this bond in a year and a half of holding.
Harland Clarke also repaid a portion of the capital in that bond, which was well timed, as I needed a bit of extra cash to allow for the Workpac and Liberty minimum parcels at primary issue.
Harland got downgraded on heightened concerns they will struggle to refinance their longer maturities. This isn’t a concern for me, as this was entirely the rationale for choosing the short 2020 secured maturity in the first place, which they should be able to pay back with cash on hand.
AMP also got downgraded in a well flagged decision due to the off/on sale of its Life business. We remain comfortable with the credit even if another downgrade eventuates.
Finally, we got the good news that the Axsesstoday bond is on track to be repaid in full sometime in September, which lifted its price from the high 80s back to par. Great result all round on that one.
So, in summary, the positioning of the portfolio continues to deliver very strong performance, while keeping a very close rein on the risk being taken. Monitoring and taking new issue value when available is likely to be the continued focus.
|Returns since inception*
|Yield to Maturity
* inception date 29 August 2017