I have just read that the S&P500 equity index finished the month only 0.5% lower than where it started, which given all that has happened in May seems remarkable. At one point from the high on the 4th to the low on the 19th it was down 400 points, or 9.3%.
I highlight this journey to show the volatility that normally exists in the equities world compared to bonds. The AusBond 0+ years (i.e. the whole market) also ended up slightly down (0.89%) for the month as interest rates again rose across the curve by about 0.25-0.30%, but the range was just 1.5% from high to low.
When there is greater uncertainty and the volatility that comes with it, having a balanced bond portfolio can really dampen the overall volatility of a wider portfolio composed of other asset classes. In fact, the Conservative portfolio below, with the lowest risk and therefore yield, returns on average about 0.38% per month of income, which would further dampen overall volatility as the AusBond index is largely low yielding government bonds.
We had some new issues this month to examine, and incorporated one into the portfolios, with more details below. The portfolios as a whole continue to offer more attractive yields, with the all investment grade Conservative portfolio now well over 5% and the High Yield portfolio well over 8%.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.23% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
There were two new issues of note this month.
Air New Zealand (Air NZ) issued their inaugural AUD bonds, with a combined $550m deal in a 4 and 6-year fixed rate structure. Both looked relatively attractive, with the 4-year yielding 5.7% being the pick in our opinion.
The second came right at the end of the month and merited inclusion in the portfolio. The annual subordinated Tier 2 bond issuance from Macquarie Bank came in at an excellent yield of 6.08% for a 5-year to the first call date tenor. Although callable and a year longer than Air NZ, we preferred this due to not relying on government support for its investment grade rating and for the yield pick-up.
We switched out the Ausnet floating rate note, which even with the elevated yield curve was yielding in the low 5%s, so we managed to improve credit quality and yield in exchange for two years longer tenor.
This move shifted the allocation of the portfolio from 41% floating/38% fixed to 31% floating/48% fixed, which given the large task ahead of the Reserve Bank of Australia to meet market expectations of rate hikes, we think more appropriately captures the opportunity.
The fund manager community seems to agree with us, with the Macquarie Bank deal being a majority fixed rate, and a Lloyds bank deal closed yesterday not printing a floating tranche at all even after it was offered.
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 38% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 6.09% and is an approximate $600k spend.
We also added the new Macquarie bond to this portfolio, but as it didn’t own the Ausnet we switched out the CBA Tier 2 bond added last month. We still very much like the safety of this bond for a good 4.6% yield, but the new Macquarie is also a quality issuer and the 1.2% pick up in yield is too good to pass up.
The portfolio as a whole now yields over 6%, which for a 61.5% investment grade portfolio is a very attractive proposition.
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 18 bonds, yields 8.43% and is an approximate $550k spend, demonstrating the concept of greater diversity in higher risk positions.
This month FIIG took a large role in the placement of another inaugural issue for WA-based mutual Police & Nurses Bank (P&N). The first AT1 Capital note from this issuer will provide them with expanded regulatory capital to continue to merge with and grow other similar mutual banks and credit unions. FIIG placed approximately 15% of the $75m issue which priced at a very attractive margin of 5.75% over the 3M Bank Bill Swap Rate (BBSW).
We switched out the now very short Workpac Trust bond, which has a June 2023 maturity. Although one of our favourite credits, being so short and with a margin lower than P&N makes this bond less exposed to the anticipated rises in interest rates that may occur over the next couple of years.
Even if they do not eventuate, the better margin of the P&N bond will provide improved returns to investors.
To view and download our Sample Portfolios, please click here.