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Wednesday 12 April 2023 by Jonathan Sheridan Trade opportunities

Wholesale Sample Portfolios Update - April 2023

There was a relatively major about turn in yields through March as turmoil in the US and European banking sector introduced significant volatility into the market.

Silicon Valley Bank failed, and depositors were bailed out. Credit Suisse was forced into a takeover by the Swiss government and regulator.

Longer term yields fell in the month as the uncertainty caused the market to increase the risk of a central bank induced recession. The central banks themselves, with the major exception being our own Reserve Bank, continued on their hiking pathways, albeit with more cautious commentary and smaller expected hikes in the future. The expectation of lower terminal rates also dragged down longer-end yields.

All this volatility made for some opportunities for investors willing to look through the short-term noise and focus on the fundamentals, particularly of the Australian banks. Primary markets were very quiet, with only three deals we participated in (one financial and one major bank subordinated, priced before the issues emerged, one corporate afterwards).

Conservative portfolio

This portfolio is all investment grade and all AUD.

The current portfolio yields 5.87% and consists of 10 bonds of roughly equal weight by value to total an approximate $500k spend.

Several changes to the portfolio this month.

The value in the new NAB bond from last month didn’t last, and it has rallied quickly into a relatively tight 5.23% yield to call. As a result, we revert to the Rabo 2027c bond which despite its higher capital price, has a better yield to call given the coupon is over 7%.

The new Liberty issue extended the tenor of their curve, and being a floating rate doesn’t extend the duration risk. The longer maturity offers a better margin and a higher yield, so we move into the longer bond from the shorter 2027 maturity.

We have seen two-way trading in the Pacific National 2031 bond this month, with sellers moving into the BNP 4.5% 2025c AT1, rated BBB- by S&P. However, this bond has a Ba1 (BB+ equivalent) rating from Moody’s, which is not investment grade. It therefore doesn’t fulfil the criteria for this portfolio, so we can’t include it.

We have been looking to replace the Qantas 2030 bond as with the rally in yields it now only offers 5.24%. Given that yield, we prefer to take the one notch lower rating of the Pacific National and only slightly longer tenor to pick up 1.3%.

This also keeps our longer duration positions intact.

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 7.43% and is an approximate $590k spend.

We didn’t own the Rabo or NAB bond in this portfolio so again, similar to last month, no change to the investment grade part of the portfolio.

The AMP bond has rallied a lot since issue, and with the yield on offer from the ‘crossover’ (one IG and one sub-IG rating) BNP 2025c bond, which we can hold in this portfolio, we decided to switch between the two. Also given BNP 2025c’s IG rating from S&P, we upsized the position slightly versus a standard HY exposure.

Medium-term forward yields have dropped, which reduces the forecast yield to maturity on the AMP, while the short end of the curve has remained relatively elevated reflecting higher rates for a little longer – this makes the shorter fixed rate BNP more attractive. The yield is also higher and nominally a better credit.

We are moving from floating to fixed, but not really increasing the interest rate risk of the portfolio given the short-dated call on the BNP.

The yield on the SocGen 4.875% 2024c has jumped as the bond has been priced to perpetuity rather than the call. SocGen has a perfect record of calling its AT1 bonds and we remain confident in this track record. This is possibly the most extreme reaction to the banking issues in the AT1s we trade, but we remain comfortable with SocGen’s credit.

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 9.90% and is an approximate $545k spend, demonstrating the concept of greater diversity in higher risk positions.

The volatility in the AT1 market has thrown up numerous opportunities which we look to take advantage of in this portfolio.

As above, with a forward yield of 6.38%, we switched the AMP bond out of the portfolio for the BNP 4.5% 2025c. Whilst we continue to very much like the credit risk of Partners Life following the Dai-Ichi Life takeover, the yield has remained too low in light of other opportunities. We therefore also removed this bond to make room for others below.

We added in the SocGen 4.875% 2024c AT1 capital note given the price move mentioned above as well as the WBC 5% 2027c, which although it has an investment grade rating has a compelling yield to call of 8.5%.

This has pushed up the investment amount to approximately $550,000 but given the yields on offer and extra diversification available we think this is justified.

To view and download our Sample Portfolios, please click here.