There is always a story in financial markets to keep the headline writers busy.
This month it was the US debt ceiling ‘negotiations’, which as usual pushed to the very edge of the US Government running out of money before again, as usual, it was sorted out and we continue along the same road, following the can we started kicking in 2008.
The Reserve Bank of Australia ‘surprised’ the market with a rate rise after pausing the previous month, and with the recent strong data there are more calls for further hikes – Deutsche Bank added 0.50% to their terminal rate forecast this week as an example.
Yields in general rose in the month, which is good news for floating rate bonds, but prices suffered a little as a result, and the forward-looking yields on the portfolios generally were a touch higher.
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.45% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
The supply we have unearthed recently on the BNP 2026c subordinated floating rate bond drove the single change to the portfolio this month.
Fixed versus floating exposure was balanced at approximately 40% each way, with the remainder allocated to inflation linked bonds. Given the sticky inflation and the desire to maximise yield whilst taking as little risk as possible, we had to find a place for this new bond with the forecast yield well over 7%.
This meant we chose to remove the lowest yielding bank paper, being the Rabo 2027c fixed rate bond at around 5.65%. With a high 7.074% coupon this means the income side of the portfolio is a little reduced, but if rates continue to increase then we will be compensated for it before long, and the current running yield of the BNP bond at 5.50% is certainly not bad, and the portfolio continues to earn >6% income.
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 39% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 7.76% and is an approximate $585k spend.
We do not own the Rabo bond in this portfolio, but the switch we did in the Conservative portfolio still makes sense. Therefore, we removed the Challenger subordinated fixed rate bond which was the next lowest yielding financial bond.
We kept the Lendlease 2031 bond despite the long maturity and lower coupon, because it gives the portfolio some optionality should rates decline unexpectedly, and as we are removing one fixed rate bond it is better for the duration exposure overall to keep the longer bond despite the lower yield compared to Challenger.
Additionally, with the high income produced by the higher risk portion of the portfolio, we generate strong income so have less need for the higher income investment grade bonds.
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 10.22% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
With no new high yield issuance in the month, we make no changes to the portfolio.
One development we were happy to see was the upgrade of the credit rating for Macquarie Bank by Moody’s towards the end of the month. This now means that the USD 2027c AT1 in the portfolio is rated investment grade, and yet continues to yield well over 9%. A great example of the superior risk adjusted yields available in the market when you look.
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