We expected July to be a relatively quiet month as companies have their year-ends and usually wait until they have published their results before asking to borrow money in the bond market.
However we were pleasantly surprised with two new deals coming to market, both of which suited our investors and were very much sought after. More details below.
As I write yields have traded in a range throughout the month, but the domestic CPI number published yesterday caused a big move to the downside in yields as it came in 0.1% below market expectations.
The relief was palpable as yields fell off a cliff across the curve, about 20bps at the short end and 15bps at the long end. It would seem that the rate hike next month is completely off the table and as usual the overreaction has caused a cut to be priced for November. We think cuts won’t come until next year.
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 $525k 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.
The two new bonds issued in the month were both subordinated issues, one from Banco Santander and one from ANZ. The Santander bond was a standard 10-year non-call 5-year structure and priced at a margin of 2.25% over 3M BBSW. They also issued a fixed rate bond at 6.444%, and both bonds were very attractively priced, although the 7x oversubscribed order book meant that the pricing was tightened 0.25% from initial guidance.
The ANZ bond was slightly different, being a 15-year non-call 10-year structure, so priced as 5 years longer than the Santander at a margin of 1.83% over 10-year swap for a fixed yield of 6.124%, reflecting the higher credit rating of A- vs BBB+. This was the largest Tier 2 bond ever issued in Australia at $1.9bn, also reflecting the huge demand.
We included both in the portfolio, switching out perennial favourite Genworth which has just become too short, being due to be called in July 2025 and the LBBW 5% 2028 which is also shorter than the ANZ.
We are extending duration slightly in the portfolio again from 4.5 to 4.8 but are definitely being compensated with a 1% increase in income and an 0.3% increase in yield from a higher rated bond.
The Genworth switch does reduce the income due to the >9% coupon being removed, but this is balanced out by the higher yield to call on the Santander.
Finally, the benefits of scouring the market for value played out as we found an RMBS bond that is displaying relative value. The portfolio held the Triton 2023-1 D note, issued in Feb 2023, which we have switched out for the near-identical Triton 2022-4 D note issued in Nov 2022. Both bonds have nearly identical collateral, apart from the new bond has a higher proportion of investment loans in the pool. For the extra 1.4% yield and a shorter WAL, we believe we are more than being paid for the slight increase in risk.
Making these changes maintained the yield at the prior month level although credit spreads tightened once more over the month.
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 6.73% and is an approximate $620k spend.
This portfolio, by virtue of the high yielding allocation, has a much shorter duration than the Conservative.
We made the ANZ and Triton changes as in the Conservative portfolio, but this portfolio didn’t hold the Genworth, so we left the Santander bond out. These additions extend the duration slightly to 3.65, which is desirable as it seems we are at or very near the peak in interest rates.
This portfolio already enjoys high margin floating rate exposure from a number of bonds including Pioneer, which was exchanged last month.
Credit spreads have contracted again this month, so the changes, while adding to portfolio yield, haven’t managed to offset the market decline, instead limiting it to a fall in yield terms of just 0.07%.
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 14 bonds, yields 8.82% and is an approximate $458k spend, demonstrating the concept of greater diversity in higher risk positions.
There were no new RMBS issues in the month so we were unable to replace the Triton notes we removed last month after their upgrade.
However, the yield on the Emeco 2026 bond crept back above the 7% mark so we are happy to bring it back to the portfolio at that level, which also helps bring the portfolio back to the desired $500k spend, although noting we are still 2 additional bonds away from that target.
We prefer to keep the discipline of diversification though and prefer to have a smaller sized portfolio than simply increase dollar value allocations.
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