September produced one of the fastest bond sell offs in a ‘normal’ market I can remember. The 10-year US Treasury bond yield is approximately 50 basis points (bps) higher than where it started the month.
Opinions as to the cause vary but are generally thought to include concern over the US fiscal position, crowding out of even the government by huge data centre borrowing and inflationary concerns driven by higher oil prices due to the Gulf conflict.
Some or all of these are probably true, but there is also a possibility the AI investment boom is normalising yields to an economy that is simply growing more quickly than investors have been accustomed to over the 20 years or moribundity since the GFC.
The RBA raised rates last week and will be looking for more to try and control the broad-based inflation. It is a tricky time to be an owner of longer dated fixed bonds but a fantastic time to invest maturing or new money.
New issuers in the month were old favourites Transgrid, Coles and Macquarie and first timers The Lottery Corporation and the Australian Rail Track Company. Did any of them make it into the portfolios? Read on to find out…
Conservative portfolio:
This portfolio is all investment grade and all AUD.
The current portfolio yields 6.71% and consists of ten bonds of roughly equal weight by value to total an approximate $510k spend.
Of the new issues, the only really interesting one was a 10-year floating rate Tier 2 subordinated note from Macquarie. This relatively unusual floating tenor could add something new to the portfolio, but with credit spreads very tight we decided not to take credit spread duration alongside the interest rate kind already in the portfolio.
The rise in yields has made the forward yield of the portfolio more attractive and it is up there towards 7% for a conservative portfolio. Amazing.
The running yield is also 6.55%, so we are very happy to sit and take the income and wait for very good value to emerge in new bonds or the secondary market.
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 41% of the total portfolio) to reflect their riskier nature.
The current portfolio has 15 bonds, yields 7.23% and is an approximate $600k spend.
This portfolio, by virtue of the high yielding allocation, has a shorter duration than the Conservative portfolio.
Highlighting the tight credit spreads across the market, the Balanced portfolio yields only 0.50% more than the all-investment grade Conservative portfolio.
The only high yield issuance in the month were the junior tranches of a heap of asset backed deals. These are generally very hard to get hold of, so we don’t often include them in the portfolios. Two banks, ANZ and Bendigo, did larger deals, with the ANZ upsizing to $2.5bn and the BB rated E tranches issued with a margin of +395 which was ~100bps better than the shorter non-bank deals.
However, as they are essentially impossible to get in the secondary market we didn’t include them in the portfolios this month.
With the yield back well over 7% and the running yield also up there, we will await the next high yield deal with a heightened anticipation.
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 15 bonds, yields 7.86% and is an approximate $450k spend, demonstrating the concept of greater diversity in higher risk positions.
There was a lot of issuance in USD that looked attractive to us in September, particularly an Additional Tier 1 (AT1) capital note from Japanese banks and more AI related companies.
However, with the relentless upward pressure on yields it is tricky to find a good entry point that doesn’t leave you immediately underwater, or taking a risk that won’t sit well with you if the AI bubble bursts.
As a result, we are sitting on the sidelines this month and enjoying the 7.8% income from the portfolio while we do so.
The rise in USD yields has made these bonds a lot more attractive compared to the AUD equivalents so we will be looking for the opportune moment to commit.
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