June had all the excitement of a prize fight in the bond market as international and domestic data drove performance and activity.
On the international front we had the first cuts in rates coming from central banks with the Europeans and Canadians first off the line in the G7 economies. Then towards the end of the month the US PCE deflator (I know, silly name but the US Federal Reserve’s favoured measure of inflation) came in lower than previous and on expectations.
These data pushed yields lower on the relevant days, but the inflation genie refused the technical knockout domestically, with the May monthly number coming in very hot at 4.0%, up from 3.6% the previous month.
This repriced the Australian bond curve upwards by a lot – almost 0.20% on the day – and countered strongly the offshore action. We ended the month just a few bps lower than where we started but the volatility was immense. Corporate credit spreads on the bonds in our portfolio declined somewhat on lower supply and the incessant bid for yields at these levels, while the wider market was wider by a few bps.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.64% 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 on the bonds in our portfolio have tightened again this month, so that while the base rates remained relatively unchanged, the yield on the portfolio has fallen by approx. 0.10%.
In this environment finding new bonds with investment grade ratings that yield over 6% remains challenging.
Given the lack of new issues in the market there was nothing to reset pricing and the existing bonds just ground tighter. The only exception was the BPCE bond where spreads widened, but that wasn’t quite enough to offset the rest of the portfolio.
The income is still strong at a healthy 6.18%, so as ever we can well afford to sit tight with the bonds we have and enjoy the benefits.
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 27% of the total portfolio) to reflect their riskier nature.
The current portfolio has 16 bonds, yields 6.80% and is an approximate $610k spend.
This portfolio, by virtue of the high yielding allocation, has a much shorter duration than the Conservative.
This month the only action in the high yield market was the exchange and new bond raising from Pioneer Credit.
It was a relatively complex process, but the existing holders look to have got a good deal by staying in their shorter bonds with a (soon-to-be consummated) new, much cheaper, senior loan in place which derisks the company a lot.
We include the bonds here at a par valuation (due to potential calls at 100,101 and 102 we are being conservative) and with a coupon of BBSW +10.25% it gives a big lift to the portfolio yield and income.
The Liberty 2023-1 E notes have now been upgraded to an investment grade Baa2 rating, but with a yield of 6.60% they are still great value for the rating and tenor, so rather than swap them out for the Pioneer we will just add it, improving diversification as well.
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 13 bonds, yields 9.12% and is an approximate $400k 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, but we had two new issues this month which we added to boost the portfolio valuation.
There was a new issue from Heartland Bank (the old Challenger Bank) towards the end of June, which as their first subordinated bond had a yield of BBSW +3.70%/7.75% which looked attractive. We added this to the portfolio along with the Pioneer Credit bond mentioned above.
Next month we will look for a replacement for the Triton 2021-2 E notes which have been upgraded to an investment grade BBB- rating and so no longer fit the portfolio parameters. We just removed that bond from the portfolio this month as we already included all the other new issues. It will likely be a new RMBS issue that comes in July.
To view and download our Sample Portfolios, please click here.