Markets have had a rocky start to the month, with heightened volatility returning following a pivot from the Reserve Bank of Australia (RBA) and surprisingly high inflation out of the US. With this, yields have crept higher, and spreads have widened, making it an opportune time to lock in returns across the fixed income market. Here we discuss the changes made to the Sample Retail Portfolio for the month of October.
Although the RBA flagged last month it was likely to slow down its rate hiking path, it certainly surprised markets when at its October meeting it increased the cash rate by 25 basis points (bp), instead of the widely anticipated 50bp. While further rate hikes are still expected, it seems to have diverged from the US Federal Reserve (Fed), which is set to continue with larger rate increases.
A stronger-than-expected US inflation read for October, reaching a 40-year high, further supports continued aggressive tightening from the Fed. The US hiking probability has shifted to 80% for a 75bp increase and a 20% chance of a 100bp hike.
Over the month yields have moved higher, with the yield on the 10-year Australian government bond currently just over 4.00% (for the moment anyway). With increased volatility and uncertainty, credit spreads have also widened, as the perceived level of risk increases also. Some of our preferred investment grade bonds and select high yield names are looking even more attractive, creating an opportunity to lock-in improved returns.
While no changes were made to the Sample Retail Portfolio for October, for the first time since inception it’s yielding above 6.00%, at 6.38% to worst. Also noting, this is with a 90% allocation to investment grade bonds, providing an attractive risk/reward.
Over the month there were no new bonds added to the retail product offering, as we continue to look for opportunities that are compelling to include.
Retail Sample Portfolio
The Sample Retail Portfolio is a balanced portfolio, where we include a mix of investment grade and selective 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 6.38% indicatively to worst* and is an approximate $200k spend.
With no new additions to the retail menu this month and satisfied with our current portfolio construct there were no changes made to the Sample Retail Portfolio. As we had mentioned last month, the beauty of a well-constructed bond portfolio is that once built it’s then a matter of sitting back and collecting the coupon payments.
With the RBA flagging a less aggressive rate hiking outlook, we have recommended investors consider adding fixed coupon bonds again, especially in portfolios with a heavy floating rate note exposure. This is because, where the return on floating rate notes is only projected at purchase date, fixed coupon bonds lock in the return irrespective of any future rate rises and provide a certain income stream.
We have an even split between the two types of bonds, which we feel is appropriate, and have the inclusion of four longer dated fixed coupon bonds. Collectively they make up close to 28% of the portfolio, and once again, believe this is appropriate and wouldn’t look to add to this.
With rates still elevated though, these longer dated fixed coupon bonds offer stand out value, especially for their investment grade credit rating. Noting that with ongoing market volatility and uncertainty, it’s the more defensive exposures of investment grade quality we would look to add to a portfolio.
We continue to look for compelling opportunities, in some cases supply has been a constraint with further bonds redeeming/maturing over the month. This has the market awash with cash looking to reinvest and taking out supply.
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 Factsheets 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).