November definitely followed on from where October left off, with lots of primary issuance activity and some large macro-economic events towards the end of the month.
In the last week we have had a new variant of COVID emerge from South Africa which sent risk assets into a tailspin last Friday night before they recovered on Monday, and then the US Federal Reserve acknowledged that the inflation cat is well and truly out of the bag, with Chair Powell on Tuesday explicitly removing the word “transitory” from the Fed’s lexicon, sending risk assets off a small cliff again on Wednesday morning.
We had at least six primary issues of interest during the month, three in the investment grade institutional market and three unrated high yield deals, which re-opened the unrated market in a big rush.
We discuss each of these in a little more detail below in the section related to the portfolio they apply to.
This will be the last update until February, so please take the time to review your own portfolio against our Samples and have a Happy Christmas and New Year.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 3.52% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.
Yields retreated somewhat from their highs last month, although still remain elevated compared to a few months ago.
The steepness of the yield curve now makes shorter dated fixed rate bonds attractive on a relative basis due to both their higher yields and their lower duration (interest rate risk) than some longer fixed rate bonds.
One such was the new issue from Computershare. A 6-year senior bond with a coupon of 3.127%, this looked attractive at primary issue both from an outright yield and an issuer diversification perspective. Currently yielding 2.67%, we have taken the opportunity for the portfolio as a whole yielding more to reduce the duration by switching this in for the similarly rated but longer Pacific National 2031 maturity.
We chose the Pacific National not because we do not like it – in fact it remains probably the best value investment grade name in the AUD market – but because at the portfolio level taking the shorter tenor and reduced interest rate risk at a time when yields have been rising and may rise more if we do get inflation or indeed even if it persists in the US and their rates rise and take ours with them, a shorter bond is better from a risk perspective.
The cost to the portfolio yield was only 0.10% and moving from an 8 year to a 5 year duration seemed worth it for the small give-up in yield.
There were two other relevant new issues for us to consider – a 10-year fixed rate bond from Melbourne Airport and a new floating rate note from AMPOL. The Melbourne Airport issue was attractively priced but at 10 years we decided against adding it as the QANTAS and Sydney Airport were a slightly better yield and in similar sectors, and we did switch the new AMPOL for the old, as a 1-year extension in tenor in a floating rate note does not add to the interest rate risk of the portfolio but increases the overall margin earned.
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 38% of the total portfolio up from 27%) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 4.30% and is an approximate $620k spend.
With the general fall back in yields and the concerns about inflation coming to the fore in the last month, we decided (in line with the Conservative portfolio) to reduce the interest rate risk of the portfolio and add some credit risk to balance out the yield.
To do this we removed the Pacific National 2031, being the longest bond in the portfolio, and replaced it with two of the three new high yield issues of the month, being Zagga (ZILT 7) and CEFT.
This removed a high duration investment grade bond from the portfolio and replaced it with two lower duration unrated bonds – in keeping with our methodology of having higher risk positions in smaller parcel sizes to mitigate credit risk.
The third new issue for the month, RACE, was an attractive switch for the SCT Logistics bond, being a slightly longer tenor but moving from senior unsecured to secured, and also generating a yield pick up.
The effect of these changes was to maintain the yield of the portfolio at 4.30% even though market yields declined by about 0.30% over the month.
We are aware it introduces more credit risk to the portfolio but this has been done in a measured way, and still keeps 62% of the portfolio with investment grade ratings.
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 6.59% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
As mentioned above, the new issues were good relative value. In the portfolio we switched SCT for RACE as above, and also removed two shorter dated bonds with lower yields in Moneytech and Elanor, both of which are due to mature in early and late 2022 respectively.
The longer tenor of the new bonds provided higher yields and a continuation of the income stream, hence removing reinvestment risk when the bonds mature. Selling bonds shortly before their maturity is a key strategy in managing the reinvestment risk of a portfolio, particularly in high yield where supply can be patchy.
Whilst market rates moved down in the month as mentioned earlier, high yield bonds are typically more resistant to broader market moves as the focus is on the individual credit. A good example of this is the PEMEX 2031 bond, which with the recent move downwards in oil prices has become better value. Given its expected level of government support we do not see this oil price move as a significant risk to the credit.
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