June 30th closed off the worst half performance-wise for bond and equity markets in decades. The positive out of all of this is that if you are looking to invest either for the first time in bonds or have more funds available from maturities or just rotating out of other assets, bonds haven’t looked this attractive in years.
Our all investment grade Conservative portfolio now yields >5.50% and the High Yield portfolio is approaching 9.00%
We are seeing AAA rated covered bonds being issued by banks with yields near 4.50%, and solid investment grade bonds well over 5.00%.
There is good variety available too with both floating rate and fixed rate bonds showing great relative value.
The only spot where we would like more supply would be in the inflation linked space, where we haven’t seen a new bond issued since the GFC. Typically strong, investment grade, infrastructure credits, these bonds should form cornerstone holdings in all portfolios, and again are now attractively priced – the trick is getting hold of them.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.51% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
Recently we have seen overseas banks issue covered bonds in AUD. Rated AAA due to their security over an over-collateralised pool of mortgages, these bonds are now showing excellent relative value. The one that piqued our interest was a five-year deal from Royal Bank of Canada, which priced with a 4.50% coupon.
We include that in the portfolio this month, switching out the only semi government exposure in the QTC 2033 bond. Whilst we like the 6.50% coupon, the opportunity to pick up yield, shorten tenor and improve credit rating means all three of the criteria for switching a bond have been met, so it should be done.
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 6.44% and is an approximate $580k spend.
This portfolio didn’t own the QTC 2033 bond, so we had nothing to switch out for the RBC covered bond. Changes this month were focused on the high yield portion of the portfolio, where Workpac have exchanged the existing bond for a smaller amount of face value of a new, basically identical bond with a 1.00% higher coupon.
While we still very much like the Workpac credit, realistically this would leave us with too small an allocation to this bond, so we switched it out for the recently issued Elanor floating rate note. A 2026 maturity from another of our favourite issuers, this bond pays a floating rate of 3M BBSW +4.50%, which if the market is to be believed is forecast o return just over 8%. A very good replacement…
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 8.96% and is an approximate $550k spend, demonstrating the concept of greater diversity in higher risk positions.
As above, we wanted to find a place in the portfolio for the new Elanor floating rate bond. High yield bonds are typically fixed rate, so when a quality issuer comes along with a floating rate bond at a good margin it is important to include it.
In this case, being a high yield portfolio, we decided to switch out the lower yielding CEFT bond. At just two years until maturity, this is a little short to be capturing the steepness of the curve in the 3–5-year area which is providing value for a lot of other fixed rate bonds.
If the Reserve Bank of Australia (RBA) does deliver, the Elanor bond should deliver around 2.00% more yield, and the current coupon of 6.31% is the same as the CEFT yield had we decided to keep it in, with the upside of potentially higher rates to come.
In the USD portion of the portfolio, the AT1 bonds just look extremely good relative value, in particular the ING 2027c with a yield to call of ~10%.
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