August kicked off with another rate increase from the Reserve Bank of Australia (RBA), and directional changes to yield moves. These are mostly driven by recession concerns than rate hikes these days, with markets accustomed to the ‘new’ environment. Here we discuss the changes made to the Sample Retail Portfolio for the month of August.
Retail Update
It was déjà vu for the start of August with another 50 basis point (bp) rate increase from the RBA, although markets were expecting as much. Overall yields moved around for the month, tightening from recent wides with noise around the potential for an upcoming recession.
The Westpac Consumer Sentiment Index dropped by 3% for the month, with most sub-indices continuing to fall materially below a year ago and long-term averages. This deterioration will bring into question the confidence of households to continue spending (and with this, the difficulty in avoiding a hard economic landing), regardless of any accumulated savings built up during COVID-19.
With markets pricing in rate cuts as soon as early 2023, the trend of yields moving higher took a pause and tightened again. Only recently have they reverted higher, but are yet to retrace recent wides. This has impacted the return on the Sample Retail Portfolio, which has a yield to worst of 5.64%, which is still attractive for a portfolio made up of a 90% allocation to investment grade rated bonds.
We expect yields to continue to move around with ongoing uncertainty, which brings even more into focus the importance of a well-diversified portfolio. Overall, a central feature of a well-balanced fixed income portfolio is that it will continue to provide a regular, stable income no matter what.
For added diversity to portfolios, we have expanded the retail product offering to include the below exposures.
- AurizonFinance-3.00%-09Mar28 senior unsecured fixed coupon.
- IncitecPivot-4.30%-18Mar26 senior unsecured fixed coupon
- PacificNational-5.25%-19May25 senior unsecured fixed coupon
Retail Sample Portfolio
The Sample Retail Portfolio is a balanced portfolio, where we include a mix of investment grade and higher-yielding exposures while still maintaining a balance between risk and return, skewed towards preserving capital rather than chasing yield.
It aims to have around 10 positions, with the higher yielding bonds in smaller parcel sizes to reflect their assumed higher risk.
The current portfolio has 13 bonds, yields 5.64% indicatively to worst* and is an approximate $200k spend.
We made a couple of minor changes to the portfolio with currently available supply being a key consideration. The high yielding ClearView floating rate note, whilst offering an attractive high return and running yield, is hard to source, so has been removed in favour of the AMP 2023 Tier 2 floating rate note.
This is also a high yield exposure, albeit lower than that offered by Clearview. With fewer options in the high yield space, we continue to look for opportunities to add exposures to the portfolio.
With a number of shorter-dated exposures being made available to retail investors in the prior month, it provides an opportunity to better diversify across maturity dates and reduce the duration of the portfolio. The duration refers to the sensitivity to interest rate moves, with longer dated bonds generally being impacted more in price terms. Although, with the market ‘pricing in’ upcoming rate hikes, it should limit the ability for yields to significantly fly higher.
However, with increased diversification, the portfolio will perform better if and when there are periods of rising yields. As such, we added the NAB Tier 2 fixed coupon bond - one of the very few Tier 2 fixed coupon bonds in the market.
It pays a 3.225% coupon, and indicatively yields over 5.10% to its 2026 call date. Other options we like with shorter maturity dates include the Incitec Pivot 2026 and Pacific National 2025 bonds.
We removed the NBN Co 2030 bond to make room for the NAB 2026c Tier 2 notes, with NBN Co providing the lowest running yield of all of our longer dated investment grade exposures (but still a very attractive yield to maturity with the potential for larger capital gain).
Although we aim to hold around 10 bonds, we currently hold 13, which provides better diversification and allows us to maintain a similar weighting to fixed coupon and floating rate exposures.
The Sample Retail Portfolio, along with the full list of retail available bonds (and Fact Sheets from our FIIG Credit Research Team on each bond), can be found on the FIIG Website here.
*Please note the indicative yield shown is the minimum expected yield to worst (YTW).