January has been a relatively quiet month as usual as most market participants are away.
On the data front it was anything but with the last quarter CPI coming in above expectations, leading to calls that the Reserve Bank of Australia (RBA) should continue with stronger rate increases at the meeting next week.
Yields, whilst being relatively volatile on low volumes, have actually moved a lot lower in the last month, by about 45 basis points (bp) on our 10 year, mainly driven by the Bank of Japan’s unexpected move to not increase the yield range on their 10 year bonds, which has meant fixed rate bonds have outperformed over the last little while.
On the trading front, whilst quiet, we have found supply in bonds that before Christmas were as rare as hen’s teeth. This has enabled us to make changes to the portfolios that are executable, which is always important.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.03% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
Tier 2 callable bonds have rallied a lot in both base rate and spread terms since the last monthly update.
We have been overweight with these callable 2027 bonds in the fixed rate coupons, and with the rally yields now look a little low in some cases.
The CBA 6.86% 2027c is the main example of this, now priced around $104 from $100 at issue in November. This level yields 5.38% to the call. Clearly CBA is a quality issuer but having 40% of the portfolio callable in late 2027 and with lower yields, we felt the time had come to rotate back to a more balanced floating allocation and also away from callable bonds.
As a result, we took the CBA bond out of the portfolio, replacing it with the senior and therefore hard maturing Liberty April 2027 floating rate note. At a price just under par and with a better margin due to the lower but still investment grade rating, the new bond adds 0.18% of yield to the portfolio as a whole, as well as better balancing hard vs callable and early vs late 2027 maturities.
With a coupon margin of 3.10% over 3M Bank Bill Swap Rate (BBSW), this also maintains the income of the portfolio up near 6%.
Also note that the two inflation linked bonds have an inflation assumption of just 2.5%. If this was increased to say 3.5%, which is still well under current CPI, the portfolio would yield 6.23%.
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 7.02% and is an approximate $585k spend.
Evolve called their bonds at $102 on the 4th of December. This gave a good result for holders since issue of over 8% p.a. but left the portfolio with a $25k hole.
Fortunately, we also had a new unrated issue in December, with ASX listed ZipMoney issuing a note from one of their receivables funding warehouses. The Zip VFN 2 B note pays a coupon of 1M BBSW +8.00% and has a very short maturity of February 2024. The current coupon of 11.03% and forecast yield of 10.39% is in our opinion excellent value for the risk, so we added it to the portfolio as a direct replacement.
We are happy with the make up of the IG part of the portfolio as we didn’t own the CBA bond in the Conservative portfolio, so no changes there.
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 16 bonds, yields 8.65% and is an approximate $515k spend, demonstrating the concept of greater diversity in higher risk positions.
We noted above (and last month) the Evolve call. Rather than simply add the Zip bond to the portfolio, we decided this month to replace the Credit Agricole GBP bond instead. Although we still like this bond, with a yield to call of 6.73%, a high yield portfolio isn’t really the place for it given its investment grade rating now it yields under 7%.
The Zip bond described above yields 10.39% for just a 1 year maturity, so is more appropriate for the portfolio.
Replacement also keeps the portfolio cash cost closer to $500k, which is our target investment amount for this portfolio.
We continue to search for supply in the QBE 2025 AT1, which is also rated investment grade, but while this still indicatively yields more than 7% we will keep it in.
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