Volatility has returned to markets given the geopolitical backdrop, however bonds provide a level of certainty during uncertain times. The Sample Retail Portfolio has been updated for March, which now yields 5.64%* indicatively. Here we provide an update for March.
The month began with a very different tone given the first weekend of March was marked with a US-Israeli led strike on Iran. Markets at first were slow to react, mostly waiting for an indication of how long and how extensive the military exchanges in the region would be, however some larger moves in equities and bonds began after the first week. Where we typically see bond yields tighten on ‘safe-haven’ demand, concerns around higher energy costs and bigger military spending stoking inflation have sent yields higher. Off the back of this, markets also pared back the likelihood of rate cuts from central banks, particularly in the US and Europe, as a result.
Bonds however continue to provide income through coupon payments, redeem when they’re due and typically see more stable capital prices than other asset classes in the face of such unpredictable and uncertain times. Bonds of a higher credit quality generally perform better as there is less credit risk compared to high yield or lower rated investment grade bonds and less ‘spread widening’ in comparison. Remembering a credit spread measures the extra yield (spread) above the ‘risk-free rate’ offered to noteholders for investing in a bond perceived as ‘riskier’.
Given the uncertainty around the situation in the Middle East at time of writing (and noting how fast-moving and dynamic the situation is), we would expect volatility to remain in markets until clarity is provided. This could also be said of the Reserve Bank of Australia (RBA), which it seems there is even more uncertainty around the rate path from here given these events, as if the task of controlling inflation wasn’t tricky enough.
With the RBA set to increase rates further at some point this year, and now a conflict moving yields higher, we see good measure in holding floating rate notes in portfolios to add diversification. The AGI Finance Pty Limited (AGIF) senior secured 2036 floating rate bond was made available to retail portfolios over the month. AGIF is the financing vehicle for Australian Gas Infrastructure Group which operate a gas distribution business across Australia. The note pays a floating rate margin of 1.60% over the 3-month Bank Bill Swap Rate (BBSW), with the current coupon rate currently set at 5.30%.
We added this bond into the Sample Retail Portfolio, and the portfolio now yields 5.64% indicatively, and this is with an 84% exposure to investment grade bonds.
Here we provide an update on the Sample Retail Portfolio for the month of March.
Retail Sample Portfolio
The Sample Retail Portfolio is a balanced portfolio, designed to offer an appropriate level of risk with return. Overall, it remains more skewed towards preserving capital rather than chasing yield.
The portfolio is expected to yield around 5.64%* to maturity for the month, with 15 bonds and has approximately AUD208k invested.
Given current market conditions, we favour a good allocation to floating rate notes and added the newly available for retail AGIF 2036 senior secured floating rate note to the portfolio. Floating rate notes add diversification and capital price stability compared to longer dated fixed rate bonds. With the coupon resetting each quarter, there is less sensitivity in price terms to base yield moves compared to longer dated fixed rate bonds. Also, in a rate-hiking outlook, the 3-month BBSW typically trends higher, providing an uplift to the coupon rate each quarter as the margin resets over a higher 3-month BBSW and provides a higher cash flow as existing lower coupon rates roll off.
To make room in the portfolio for the AGIF 2036 note, we exited our Pacific National holding fixed rate coupon bond. While we hold no concerns around the Pacific National credit and noting S&P Global recently updated its outlook on the credit, there does remain ongoing execution risk as the company implements its renewed strategy. We also have an existing holding in Aurizon Network Pty Ltd, which is a similar exposure to Pacific National.
We continue to look for new floating rate notes that become available to reduce the portfolio’s duration and improve diversification.
The Sample Retail Portfolio, along with the full list of retail available bonds, can be found on the FIIG Website here. Factsheets are also available via MyFIIG.
*Please note the indicative yield shown is the expected yield to the assumed maturity/call dates of
the bonds included in the portfolio, based on swaps rates at the time of writing.