February has seen the market reprice higher in yield as the reality of sustained inflation has started to filter through.
The Reserve Bank of Australia (RBA) has notably changed its commentary after the expected 25 basis point (bp) rate hike on the usual first Tuesday to a more hawkish stance, all but confirming at least two more hikes were coming.
This has reversed much of the previous months’ fall in yields and made secondary prices more attractive.
We are also seeing an uptick in primary issuance, with Suncorp and ANZ both issuing subordinated bonds at attractive levels, and yesterday NAB and Telstra also both issued, with Telstra’s being the company’s first domestic issue since 2017.
Conservative portfolio
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.26% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
Following on from last month’s switch out of the Tier 2 bank bonds, we note that the Rabo 7.074% 2027c bond has rallied a lot and only offers a yield of 5.80% to the call.
As mentioned, NAB issued a new bond yesterday with a yield of 6.17% (estimated at time of writing). Given the short tenor extension over the Rabo and the same nominal credit risk, we prefer the extra yield and so make the switch.
The pricing in of a higher terminal rate has improved the yield of the portfolio as a whole so we are happy with the switch we made last month from fixed to floating.
We keep the longer dated fixed rate bonds in the portfolio in case we do have a hard landing and rates fall as a result, giving the portfolio a positive exposure to duration in that scenario.
Also again, 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 7.19% and is an approximate $585k spend.
We didn’t own the Rabo bond in this portfolio so again, similar to last month, no change to the investment grade part of the portfolio.
We also believe we have the best value AUD bonds in the market in the high yield section, so no change there this month either.
We are content to pick up income when there are no obvious changes to be made – one of the great strengths of a bond portfolio.
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 8.88% and is an approximate $523k spend, demonstrating the concept of greater diversity in higher risk positions.
With no new issuance in the high yield space to take our attention, we keep the portfolio unchanged.
Supply in the QBE 2025c has been forthcoming in the last month. We had a yield target for this bond of 7%, which was achieved in trading, although currently it is just below.
We will continue to monitor this as the bond we replaced last month, the Credit Agricole GBP 2026c is on the nose at 7% and at that level we are ambivalent about which to include.
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