Switzer Higher Yield Fund February 2021 Portfolio Update

Welcome to the February 2021 Investment Update for the Switzer Higher Yield Fund. Click here to download the report.

Performance Summary

For the month of February SHYF delivered a return of 0.29% net of fees, compared with 0.12% for the benchmark RBA Cash Rate + 1.5%. Since inception the Fund has delivered a return of 0.81% net of fees, compared with 0.30% for the benchmark RBA Cash Rate + 1.5%.

At the end of the month, the Fund had a weighted average interest rate of 1.75% compared with the actual RBA Cash Rate of sub-0.10%. The average S&P long-term credit rating of the Fund is A. The Fund has exposure to 45 different bonds/hybrids across the capital stack, including a 23.1% weight to highly rated Australian state government bonds, and has a 15.6% weight to cash.

Market Commentary and Outlook

February was an absolutely fascinating month and a complete blood-bath for interest rate duration lovers, or those loaded up on “fixed-rate”, as opposed to “floating-rate” debt. To be clear, SHYF runs near-zero interest rate duration risk (that is, it is effectively floating-rate) precisely to minimise these hazards. Accordingly, the portfolio performed well in February, posting solidly positive returns.

For decades, the lazy long duration trade had worked well and few had reason to doubt it. But when the seemingly inevitable partial normalisation in yields arrived in February, it felt as if the entire market wanted to suddenly de-risk by selling their long-bond duration exposures. The issue, of course, is if everyone wants to sell at the same time, there are going to be few folks to take the other side of the trade (save the central banks). And so, until the RBA started buying bonds, the value of Australian fixed-rate debt securities went into freefall.

There also remains upward pressure on the Aussie dollar, which after piercing $US80 cents in February is currently elevated around $US77 cents. Australia’s trade-weighted exchange rate is likewise more than 6% above its level at the end of 2019, although this is off the 9% plus increase it had registered in late February (it pulled back right at the end of the month).

With wage growth running at 1.4% annually – miles below the 4% threshold required to generate core inflation in line with the RBA’s target 2-3% band – and the 6.4% unemployment rate similarly consistent with massive excess labour market capacity, the RBA is not remotely close to hitting its full employment or inflation targets. Juxtaposed against the spectre of fiscal policy swinging into a highly contractionary mode in the second half of 2021, it does beg the question: is there more that the RBA could be doing right now?

Across February credit spreads tightened throughout much of the month, albeit widening for a range of different reasons in the final few days. When bond spreads compress, their prices increase and they can then be sold to generate a capital gain. In the ASX hybrid market, two new deals from Macquarie Group and Commonwealth Bank of Australia (CBA) pushed five-year major bank hybrid spreads from about 261bps at the intra-month lows to circa 276bps. Hybrid spreads accordingly remain a long way above their post-GFC tights of around 235bps. The good news is that these two deals, which were expected, arguably clear away much of the near-term supply risk.

In the Tier 2 bond space, five-year major bank spreads jumped from 124bps (in line with the post-GFC lows) to 144bps as a result of profit-taking in the latter part of the month. The technical outlook for BBB+ rated major bank Tier 2 bonds in Australian dollars (AUD) is positive given banks have focused on issuing large transactions in foreign currencies, often well inside their AUD curves. This includes Macquarie and CBA in US dollars, and ANZ in euros.

Finally, in semi-government bonds, the constant-maturity 10-year index for New South Wales (NSW) was flat in February, bobbing around 21bps over government bonds. There was, however, an appreciable increase in five-year NSW G-spreads, which rose from 9bps to 13bps, likely as a result of the broader interest rate volatility and risk-off tone at the end of the month. This was despite a huge improvement in the NSW budget deficit, indicating that new supply will be a lot less than the market had hoped.

A similar story has played out with the Commonwealth budget deficit; data from January showed the underlying cash budget for 2020-21 is running about $14bn better than the run-rate required to hit Treasury’s full-year forecast of a $198bn shortfall.

While the budget deficit for 2020-21 will still be the largest peacetime deficit on record, the improving trend shows Government is likely to revise down its forecast substantially when the Treasurer delivers the budget in May.

Investment Objective

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 (Coolabah). 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.

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