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Wednesday 05 June 2024 by Jonathan Sheridan Trade opportunities

Wholesale Sample Portfolios Update – June 2024

May was a quieter month in the bond market than April. Weak employment numbers in the middle of the month pushed yields lower but then a stronger than expected monthly inflation number pushed them back up again. We ended the month basically where we started.

In the corporate market there wasn’t much activity until the end of the month when NAB became the final major bank to issue a 10-year first call subordinated bond which attracted huge interest.

Europe could cut rates this month coming as the first major central bank to do so since inflation struck post COVID.

As usual we take a longer term, balanced view to our portfolios. Commentary below.

Conservative portfolio:

This portfolio is all investment grade and all AUD.

The current portfolio yields 5.74% and consists of ten bonds of roughly equal weight by value to total an approximate $480k spend.

As a reminder, the portfolio contains a government and semi government bond with low yields. These are not expected to be held to maturity, but instead traded if and when yields fall. Therefore, the portfolio yield is understated compared to expectations given it is unlikely this low yield to maturity will be realised on these bonds.

Credit spreads have tightened over the month, so that while the base rates remained relatively unchanged, the yield on the portfolio has fallen by approx. 0.15%.

In this environment finding new bonds with investment grade ratings that yield over 6% is challenging.

This is why we included the new 10 year bond from NAB in preference to the WBC 7.199% 2033c. the yield pick up was modest, about 0.20% p.a., but as both are issued by major banks and these are essentially identical, this was worth doing.

In the month there was also a new bond from first time issuer Arc infrastructure which priced with a 6.018% coupon. However, by the time of writing, this yield is below 6% and as such we kept the BPCE 2033 bond in the portfolio despite its high capital price. The running yield of nearly 7% is still attractive.

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 15 bonds, yields 6.52% and is an approximate $575k spend.

This portfolio, by virtue of the high yielding allocation, has a much shorter duration than the Conservative.

With slightly more credit risk in the portfolio than the Conservative, when spreads contract as they did in the month that lowers the yield more in this portfolio.

Additionally, we have removed the Zip VFN2-B bond as it is due to be called in early June. This removed a bond yielding ~12% which also adds to the lower yield vs the prior month.

In the investment grade portion we increased the duration and yield by switching out the Santander 2031 bond for the new NAB 2034c given the value on offer.

We note the recent result from Pepper Money which was disappointing and very shareholder friendly. At this stage we keep the subordinated bond in the portfolio but will be watching the company performance closely over the next few months.

High-Yield portfolio:

The High Yield portfolio looks to generate a higher 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 12 bonds, yields 8.86% and is an approximate $393k spend, demonstrating the concept of greater diversity in higher risk positions.

Trying to keep a $500,000 cash value of a properly diversified and exclusively high yield portfolio is proving more and more difficult as time goes on.

This month we removed the Zip VFN2-B bonds as above due to their upcoming call, as well as the SocGen 2024c which has basically priced to the par value of its expected call in September.

We also removed the Macquarie Bank USD 2027c bond as with a yield below 6% and an investment grade rating, it no longer has a place in a high yield portfolio. How times have changed – a year ago this bond yielded 9.5%.

Peet exchanged their upcoming 2024 maturity for a new 2029 maturity bond but it doesn’t settle until the 7th of June so we will consider it for next month’s portfolio, although we will be wary of having too high an exposure to the one issuer as we already have the 2027c in the portfolio.

We note the comment above regarding Pepper Money as well.

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