Well markets finally started to get a bit interesting over October. Equities continued their relentless grind up, even in the face of rising inflation and bond yields, which was apparently due to higher expected earnings. There is always a story somewhere in equity land that justifies ever higher prices.
What really became interesting in terms of bond markets was towards the end of the month, when the Bank of Canada (analogous to Australia as it is a relatively small, resource-based economy) abruptly stopped their Quantitative Easing (QE) program. They announced they could start raising interest rates as early as April next year, after being resolute that it would be at least a year until that was necessary.
That presaged a similar event domestically late last week, when the market basically told the Reserve Bank of Australia (RBA) that it thought it was a liar, and there was no way they would hold rates at 0.10% until 2024. Markets priced in 1.75% of rate hikes by the end of 2022 and quintupled the yield on the 3-year government bond that the RBA had been keeping at 0.1% in line with its cash rate target.
These massive moves were largely in response to a very hot New Zealand inflation number, and put the acid on the RBA for its meeting on Tuesday, where it abandoned the 3 year government bond target of 0.1% as expected, yet maintained the overnight rate at 0.1%.
In terms of bonds, we are excited to include some bonds in small parcels which were not previously able to be added to the portfolios due to their large minimum parcel sizes. Our new Small Parcel Trading initiative now allows this, and so we added the Société Générale 2024c, NCIG 2027c and Nickel Mines 2024 bonds to the relevant portfolios.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 3.55% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.
The continued increase in yields has made this portfolio all the more attractive, although it does have that sensitivity to these kinds of moves in yields, as the longer dated bonds became cheaper. The QAN 2030 for example is now yielding over 4% which looks like good value.
Overall, the portfolio is now yielding over 3.50%, up from 3.09% last month, although a lot of this is due to the upward movement in the swap curve from 2-years out, which has materially increased the forecast yield of the floating rate notes.
If the RBA do end up sticking to their guns then this is not likely to be achieved, as the current low rates will average out the final yield to the downside.
We made no changes to the portfolio this month as there was little attractive primary issuance.
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 27% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 4.31% and is an approximate $640k spend.
The first of the Small Parcel Trading bonds has been included this month in the Balanced portfolio – the Société Générale 2024c AT1 bond. As part of our theme of coming lower in the capital structure in large, well-capitalised businesses, we include this hybrid security from one of only 30 Globally Systemically Important Banks. Usually restricted to $500k minimum parcels, these are now available in $10k parcels just like all our other Direct Bonds.
Yielding around the mid-3% for just a short 2.8 years to the expected call date, this bond is very good value for the risk in our opinion. We removed the AMPLife subordinated floating rate note to make way for this as with the 1-year shorter tenor and the fixed rate coupon, we view this as better value even though the yields on the bonds look similar at first glance. As mentioned above, floating yields depend on the returns forecast by the swap curve being realised, whereas there is no risk to that with a fixed rate bond.
With a yield around the mid-4%, the Balanced portfolio is also looking very attractive given 68% of the portfolio is still rated investment grade.
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 16 bonds, yields 6.30% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
It is very exciting to be able to include two new bonds that have not been available thus far due to their large parcel sizes. Regular readers will remember the NCIG 2027c bond from the table at the end of the article.
This is in our opinion probably the best value bond in the available bonds to clients. It once more fits the theme of coming down the capital structure to increase yield in otherwise large well capitalised businesses. In this case this is by the ‘structural subordination’ of the bond, as while is it secured, this is at the holding company level of the group, and so in practice this ranks lower than the secured operating company bonds.
The Nickel Mines 2024 senior bond is also good value for its short tenor and comfort from an ASX-listed company with an approx. $2.5bn market capitalisation.
High yield bonds as mentioned are more resistant to higher risk-free rates, and so the portfolio yield has not moved up as much due to the movement in these as did the other two portfolios, but the addition of the NCIG bond has increased the portfolio yield to a very healthy 6.30%.
Other USD bonds we like:
Given we now have the ability to include these bonds in the main portfolios due to Small Parcel Trading, we will discontinue this section of the article.
To view and download our Sample Portfolios, please click here.