Welcome to the May 2021 Investment Update for the Switzer Higher Yield Fund (SHYF or the Fund). Click here to download the report.
For the month of May, the daily liquidity, zero-duration, average A rated SHYF Fund delivered a return of 0.09% net of fees, compared with 0.13% for the benchmark RBA Cash Rate + 1.5%. Since inception the Fund has delivered a return of 1.22% net of fees, compared with the actual RBA Cash Rate (0.01%), the AusBond FRN Index (0.24%) and the benchmark RBA Overnight Cash Rate + 1.5% (0.69).
At the end of the month, the Fund had a weighted average interest rate of 1.55% compared with the actual RBA cash rate of sub-0.10%. The average credit rating of the Fund is A, and it has an average AA ESG bond rating from MSCI. The Fund has exposure to 55 different bonds/hybrids across the capital stack, including a 36.4% weight to highly rated Australian state government bonds, and has a 9.7% weight to cash.
Market Commentary and Outlook
There is an investment aphorism that implores, “sell in May and stay away”, and that principle carried weight in some, but not all, of the bond markets in May 2021. Put differently, it was a month characterised by cross-currents in fixed-income performance.
On the negative side of the ledger, the ASX hybrids market was soggy as investors punted on the prospect of a new major bank deal, with the ensuing selling dragging down the index about 0.15% in May and causing 5-year major bank hybrid credit spreads to rise from 270 basis points (bps) above the quarterly Bank Bill Swap Rate (BBSW) to 274bps. As expected by Coolabah, ANZ launched a new 6.7 year hybrid (ASX: ANZPI) on the first day of June, priced at 300bps above BBSW in what Coolabah assessed was a decent, circa 14bps concession to our fair-value curve estimate around 286bps.
On a more positive note, the AusBond Floating-Rate Note Index ground-out a decent 0.07% return in May. Whereas the credit spread on Coolabah’s constant maturity index for 5-year major bank senior bonds moved wider from 46bps to 49bps over BBSW in May, one notch down the capital structure the major banks’ Tier 2 bond spreads tightened over the month from 135bps to 131bps over BBSW.
The weak performance in major bank senior bonds was partly influenced by Westpac printing the first monster senior deal since before the pandemic. Coolabah had repeatedly predicted that a major bank would come to market with a senior deal before 30 June, a view that was rejected by the majors themselves and the market. We expect major bank senior unsecured bond spreads to continue to move wider once the supply-side eventually comes back online in the local market.
Another sector that experienced headwinds in May was the semi-government bond market where the constant-maturity, 10 year spread on AA+ rated NSW government securities jumped from 18bps above Commonwealth government bonds to 25bps in May as the market tried to price in an aggressive RBA tapering of its quantitative easing (QE) policy. Coolabah believes that the market’s hard tapering assumption is misplaced and that the RBA’s third tranche of QE (aka “QE3”) will in practice be larger than the first two stanzas as the RBA very slowly transitions out of this policy over the course of 2022.
Coolabah recently argued that the RBA has provided clear signalling that in July it will move to a new form of open-ended QE at the current run-rate of $5 billion of bond purchases each week, which will be periodically reviewed. This will avoid the policy rigidity of static, five monthly QE programs of $100 billion each, and allow the RBA to smoothly glide towards a tapering into 2022. If the data is very positive, the RBA can taper in 2022. If it is negative, the RBA can maintain the current bond purchase pace. It will also mean that the extended $5 billion per week of purchases between mid-September and mid-December plus the eventual tapering into 2022 will involve the RBA likely acquiring substantially more than $100 billion of additional bonds.
This is yet another case of the market, and many economists, underestimating the RBA’s commitment to restoring sustainable full employment and inflation within its target band. It demonstrates that the RBA is really sticking to its “nowcasting” paradigm and avoiding falling into the trap of overestimating wages and inflation based on rubbery forecasts.
The Switzer Higher Yield Fund is a zero-duration bond fund which aims to provide investors an attractive cash yield with low capital volatility by investing in a portfolio of high quality and liquid fixed income securities. The portfolio is managed by Coolabah Capital Institutional Investments. The Fund aims to achieve total returns which are between 1.5% to 3.0% greater than the RBA Cash Rate after fees and expenses on a rolling 12-month basis.
DISCLAIMER: Past performance is not a predictor of future returns. This update has been prepared for information purposes only. Any figures provided in this document are unaudited and approximate. This post does not contain investment recommendations nor provide investment advice.
You are strongly encouraged to obtain detailed professional advice and to read any relevant offer document in full before making any investment decision. This is not an offer to invest in any security or financial product.
© 2021 Contango Asset Management Limited.