March has been dominated, as expected, by newsflow about the Iran war. Over a month in and we seem to be no closer to a resolution as the all-important Strait of Hormuz remains, to all intents and purposes, closed.
This uncertainty has put bond issuers onto the sidelines, with only a few deals being priced in Australia. In the US the large hyperscalers priced massive data centre deals with 30, 40 and even 50 years tenors, but these were one-offs and haven’t leaked into our market.
In the same space, as an example, Next DC was looking to raise a subordinated bond but didn’t like the price expected by the market so went and did a twice-as-large private deal with a Canadian pension fund.
There were a couple of new issues – NBN Co reopened the market in early March – and we participated in one investment grade deal and one high yield.
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.28% and consists of ten bonds of roughly equal weight by value to total an approximate $500k spend.
The investment grade new issue in March that interested us was the floating rate part of the trio of bonds issued by US telecom company Verizon.
Rated BBB-/Baa2, the 5½-year floating rate bonds priced with an attractive margin of 2.05% over 3M BBSW, which is currently a forecast yield of 6.65%.
To manage the risk of this portfolio outside the frontline credit risk (which is mitigated by the portfolio being all investment grade), we decided to switch out the WBC 6.085% 2036c which was the longest of the subordinated fixed rate bonds in the portfolio.
Whilst we increased credit risk by dropping from an A- rating to BBB-, we reduced the interest rate risk from a modified duration of 7.2 to just 0.2, which given the way yields are bouncing around due to the war we think is a better way to position the portfolio.
We now have a 40:40:20 fixed to floating to inflation linked allocation which is well aligned for whichever way the conflict pans out.
The other IG issuer that priced a bond in March was NZ renewable electricity company Meridian Energy. We like the issuer, but the pricing was too low at 6.2% to justify inclusion, although we did like the 7-year tenor.
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 31% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 7.05% and is an approximate $580k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
This portfolio didn’t hold the WBC bond, so we couldn’t use that for the Verizon switch.
Given the point of this portfolio is to take more credit risk than the Conservative, we decided to instead switch out the NSW government bond. Whilst this is attractively priced at 5.5% for the Aaa rating, in the spirit of reducing duration and adding a little more credit risk this was the obvious, and lowest yielding candidate.
The high yield portion of the portfolio is largely allocated to fixed rate bonds due to their better availability, so reducing duration in the high-grade portion makes sense.
This portfolio is now a 46:37:17 fixed to floating to inflation ratio, which follows the high yield allocations to fixed.
Zagga tapped their existing floating rate bond during the month which would have been a new issue, but we already held this bond in the portfolio from its original issue back in December so had nothing to add. The strong demand in the tap book reaffirmed the strong relative value on offer here and also showed that not all ‘private credit’ is equal.
Thera called their 9% Apr2027 bond a year early so we will have to find a replacement for that one next month when the bond is redeemed.
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 17 bonds, yields 7.79% and is an approximate $480k spend, demonstrating the concept of greater diversity in higher risk positions.
We were hoping for a new unrated bond from ASX-listed data centre business Next DC, but ultimately, they weren’t happy with the pricing the market offered them and ended up doing a large private deal with a Canadian pension fund.
As this portfolio also already owned the Zagga bond, the tap was of no use to us in terms of optimising the portfolio. So, another month with no new high yield issuance to add to the portfolio.
In fact, with the Clearview take over the subordinated bonds have been upgraded to investment grade with rating agency, Fitch. Another bond we will need to replace when we get sight on a new issue, along with the Thera that has been called.
Yields have moved higher though as a result of the Iran war and so those bonds that were languishing close to 6% last month are now closer to 7%, which is really where this portfolio’s base level for inclusion should be.
To view and download our Sample Portfolios, please click here.