The US government has shutdown (yet again) as I write this on the 2nd of the month. Markets have basically ignored it as everyone will eventually get paid and spending will resume. I assume that these government employees aren’t the ~40% of Americans who have less than $400 immediately available to them…
Bond yields domestically haven’t done much as the RBA signalled they are very data dependent in holding rates steady on the last day of September, although the market had another cut priced for 2025 which was removed in the lead up to the meeting.
US rates on the other hand have fallen a fair bit in September as it becomes clearer their economy is slowing. The most recent point was a poor ADP private jobs release on the 1st of October which showed a large fall, against expectations for a solid rise in jobs created.
Labour markets look to be the driver of central bank behaviour at the moment now inflation seems to be (mostly) under control.
With this stability the new issue market remains hot with several new bonds coming to market amid hugely oversubscribed order books. We discuss these more below.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 5.58% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
There were four new bonds priced in the month, all of which were attractive. One was not rated investment grade so we can’t include it here, but we switched in the other three.
The highest yielding was a rare AT1 Capital security or hybrid in the Over-the-Counter (OTC) market issued by UBS. With the domestic market for these now closed after APRA banned them, a foreign issue was just what the market wanted, with a hugely oversubscribed order book resulting in final pricing well below the initial 7% mark announced at launch. At 6.375% for a 5 year first call period these are still attractive though, and we took the opportunity to reduce the duration in the portfolio a bit by switching out the ANZ 2045 subordinated bullet for a 0.30% pick up in yield.
We are always aware of the potential overweight to the financial sector as they simply issue more bonds than the true corporates but this month it is one in, one out. AGL issued a 10-year senior bond and whilst rated two notches lower than the HSBC senior bond from last month, the 0.50% yield pick up and move into a utility is worth it in our opinion for the same tenor.
The final new bond is a floating rate issued by AMP Bank, which again priced off an 8 times oversubscribed order book, but offers a better margin for a shorter tenor and the same rating as the Ausnet corporate hybrid, so in it goes.
The average rating of the portfolio moves down a notch to BBB+ but with the yield picking up by 0.15% we think this is a good trade off, particularly as the risk of a hard landing seems to be in the far distance now as the domestic economy at least seems to be in a broad equilibrium – of course this may change and quickly but we can always react!
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 15 bonds, yields 6.13% and is an approximate $545k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
We made the changes as above in this portfolio apart from the AMP for Ausnet switch as we don’t carry Ausnet in this portfolio.
However, the Grow Asset Backed Security (ABS) deal is now very short and in the absence of any other compelling ABS deals we have participated in we switch in the AMP for this one to add yield. Over time the Grow bond has also been upgraded in rating and now sits at A3 (A- equivalent), so by returning to a BBB- exposure we can increase the yield without increasing the duration as both are floating rate.
As mentioned above we are always aware of the exposure to the financial sector, but the newly issued Judo bond provides a big pick up over the existing Aurizon floating rate note for just one notch lower in credit rating.
This does push the exposure to sub investment grade, but the Balanced portfolio allows this kind of flexibility in the measured search for yield and we manage the risk with a smaller position size.
These changes put the yield back above 6% whilst still maintaining an average investment grade rating, which is strong relative value.
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 16 bonds, yields 6.625% and is an approximate $500k spend, demonstrating the concept of greater diversity in higher risk positions.
We added the new Judo bond to the portfolio despite it yielding under 6%. This is the state of play for the top end of sub investment grade credit in the Australian market right now.
The Heartland bond is in a similar situation – rated sub investment grade by Fitch – and yielding just a modest 5.50%. However, this bond has a current coupon of 7.28% so is a useful contributor to the high income of this portfolio.
The spreads on the French issuers have come back down since last month’s widening after the vote of no confidence was passed. I don’t think the situation has changed but the market prefers known risks to unknown ones.
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