They say a week is a long time in politics – well a month is certainly a long time in the bond market….
Last month was about the market turning direction, pricing in rate cuts and lower terminal rates after the consensus view was that the world was heading for a recession and central banks would have to lower rates in the middle/end of 2023.
However, US Federal Reserve Chair Jerome Powell’s speech at the Jackson Hole central bankers’ gathering put paid to that in no uncertain terms. As a result, rates have now backed up to their previous highs – the 10-year US Treasury is just under 3.20%, which is a high since mid-June.
New issues have been quiet since the rush of Tier 2 bank bonds, but there were some attractive Residential Mortgage-Backed Securities (RMBS) deals, one of which we participated in where the higher rated notes offered very good margins.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.64% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
With yields rising over the month this portfolio now yields over 5.5%. Amazing that a year ago this portfolio yielded just 2.68%. The world has changed a huge amount in that time!
The fixed rate bank Tier 2 bonds still look like good value, and deliver a good cashflow to clients, so we kept them in the portfolio despite higher market rates.
In RMBS, as mentioned above, new issues are looking like good value. Last year A rated notes were issuing with margins of BBSW+1.50%. Triton just issued a deal, which we participated in, where the A rated notes issued with a margin of BBSW+3.50%. For a short 3.3-year weighted average life (WAL) this is a very strong margin, so we switched out the lower rated and longer WAL Salute series yet achieved an increased margin. The very essence of a good switch is when you can get the trifecta of lower risk – credit and duration – and higher yield – and we got all three here.
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 6.62% and is an approximate $580k spend.
We did the same switch as above, which adds a second Triton RMBS to the portfolio. It is a good reminder that each individual RMBS bond is discrete from another, even though they may be issued by the same organisation. This is because each pool of mortgages has its own characteristics, and the tranche might be different – as is the case here, with the 2021 vintage being the BB rated E tranche and the 2022 being the A rated C tranche. This makes a difference in terms of risk and return.
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 17 bonds, yields 8.79% and is an approximate $550k spend, demonstrating the concept of greater diversity in higher risk positions.
Additionally, this month we are closely monitoring the IAMGOLD situation given the Moody’s downgrade. There is some time until its maturity in 2028, with no doubt plenty of water to flow under the bridge before their new mine is up and running. For now we will take this out of the portfolio until the situation becomes clearer.
As a replacement we have a new bond from QBE – their USD 5.25% 2025 call AT1. Priced at a yield to the call in under 3 years of over 7%, and with QBE showing improvement in their results over the last few periods, we like it as another addition to the thematic of moving lower in the capital structure of large, well-capitalised companies. Although it is rated Baa2 (BBB equivalent) which is investment grade, we think the yield justifies its place in this portfolio.
The impact on the portfolio yield has been minimal – another benefit from having smaller, more diversified positions in high yield in that one individual position does not materially impact the portfolio as whole.
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