Inflation, inflation, inflation – the answer to any question posed to an investor about the most important factor for the rest of 2021 and beyond. On the 10th of June US Consumer Price Index (CPI) was released showing a 5.00% increase for the prior 12 months. The rate excluding food and energy of 3.80% was the highest since 1992.
For fixed income investors in particular, where the aim is to maintain capital rather than grow it, inflation can be damaging to returns. Therefore, higher than expected inflation is usually bad as yields rise to compensate and bond prices fall.
However, the US Federal Reserve announced they would begin to think about thinking about raising overnight rates. The market took this to mean they would effectively combat any excess inflation and therefore yields, which had risen over the past couple of months, actually came down.
Investing is hard!
The other key event of the month was the $250m issue of the 6.25% 2026 high yield AUD bond issued by Emeco, which was a rare opening of this market for a sub-investment grade rated issuer in that size. FIIG participated strongly with a $45m allocation of the initial deal size of $150m, which no doubt in part due to our strong representation gave the issuer confidence in the deal, which was upsized to $250m.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 2.87% and consists of 10 bonds of roughly equal weight by value to total an approximate $500,000 spend.
Again in June there were no primary issues that presented better relative value than the secondary issues already in the portfolio, so we kept the portfolio the same. Yields were broadly flat, although fluctuated up and down within a range and the portfolio as a whole ground in by a further 0.03% to finish May at a yield of 2.87%.
Balanced portfolio:
The Balanced portfolio adds higher yielding bonds to the base Conservative portfolio to achieve a higher yield, while still 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 24% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 3.58% and is an approximate $600,000 spend.
The new issue from Emeco as mentioned above was stand out relative value for an AUD high yield issue, and with significant volume on offer was an easy choice to include in the portfolio. Given the current size is a little over $600,000, we decided to take out the Liberty 2021-1 E notes rather than add further spend to the portfolio.
We still believe BB rated class E notes in RMBS transactions represent the best regular relative value in sub investment grade AUD, as there are typically one to three new issues providing supply in a given month, but as these particular notes had a short WAL and have rallied in price to yield in the low 4.00% area, we decided that Emeco, even after it has also rallied post issue to a yield of 5.19%, was better value, adding around 0.80% to the Liberty yield.
High Yield portfolio:
The High Yield portfolio looks to generate a high 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 5.17% and is an approximate $500,000 spend, demonstrating the concept of greater diversity in higher risk positions.
The yield on this portfolio actually increased from last month, flying in the face of the overall market tone of slowly grinding lower yields.
The main reason for this was the switch of Liberty 2021-1 E for Emeco as above, and a rebalancing of the USD portion of the portfolio, of which further details below.
Firstly, we took out the NCIG 2031 bond. At issue with a coupon of 4.70%, this investment grade rated bond didn’t fit the high yield parameters of the portfolio due to its rating but it certainly did based on the yield. However, as we expected, this imbalance couldn’t last and it has rallied to such an extent that with a yield in the low 4.00%s, we can no longer justify its inclusion. This issuer remains the best value USD issuer in both Investment Grade and High Yield in our opinion however.
Secondly we removed the Rockpoint 7.00% 2023 bond, which has been trading at a very consistent yield to the par call in March 2023. The yield to this call is just 2.60%, and while the yield to maturity in 2023 is 5.01%, our view is that the call is more likely than not, hence us looking for a better option than 2.60%.
The additions to replace these two bonds were new bonds to the FIIG direct bonds service.
Edison International 2026c is a subordinated bond from the second largest regulated electricity utility in California, with a $21.9bn market capitalisation. One of our preferred ways to find yield in this environment is to come lower in the capital structure of large, stable companies, and in this case we think this callable bond offers the default risk of an investment grade issuer (as its more senior bonds are rated IG) and yet still shows good relative value at 4.40% to the 2026 call.
PEMEX is the Mexican national petroleum company, which represents 99% of the oil production of Mexico. An effective arm of the Mexican government, PEMEX is an essential contributor to the Mexican economy, at times providing up to 40% of the government’s revenues and being supported by capital injections for exploration. With its budgets having to be approved by the Mexican parliament, we believe this quasi-sovereign issuer offers good relative value, being rated investment grade by S&P (due to the sovereign support) and high yield by Moody’s (who place slightly less weight on this likely support).
At a yield of nearly 6.00%, we think that despite the 2031 maturity, the yield justifies the longer dated exposure.
Other USD bonds we like:
The table below continues to show other USD bonds we like that don’t fit the parameters of this particular portfolio.
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