Purchase of Betashares Western Asset Australian Bond Fund ETF (ASX: BNDS)

The Betashares Western Asset Australian Bond Fund ETF (ASX: BNDS) has been added to portfolios that have a fixed interest component. The new position has been funded by the sale of the iShares Treasury ETF (ASX: IGB) and a reduction to the Janus Henderson Tactical Income Fund position. The holding will sit within the Australian Fixed Interest asset class.

Before discussing the rationale for the change, a quick reminder on a few key characteristics of fixed interest securities. Firstly, there is an inverse relationship between the yield on a bond and its price. As yields increase, all things being equal, the price of bonds decrease and vice-versa. Secondly, credit spreads refer to the difference in yields between two bonds of the same maturity but different credit ratings, typically comparing government bonds and corporate bonds. The spread indicates the additional compensation investors demand for taking on higher credit risk.

What Happened in March 2023?

Back in March 2023 when we reduced the exposure to the iShares Treasury ETF, there were growing concerns about the banking sector and the potential economic effects of reduced liquidity. Bond investors reacted quickly by pricing in interest rate cuts, leading to a sharp decline in yields across bond maturities.

Australian 10 Year Government Bond Yield

Source: FactSet, 26th June 2023

We highlighted that despite financial stability concerns, inflation was still above levels that the RBA was comfortable with, and that the drop in yields and expectation for rate cuts by the RBA looked overdone in our view.

Current Market Environment

Fast forward a few months, and concerns in the banking sector have eased while inflation continues to be an issue. The Australian labour market remains tight with more jobs added to the economy than expected – this is a key concern for the RBA as services-related inflation remains stubbornly high.

Since March bond investors have again pivoted dramatically in terms of their expectations around the future path of interest rates. Ultimately, bond yields have once again risen to levels that better reflect the inflationary environment and likely monetary policy path of the RBA.

With more reward (attractive levels of income and reduced positive correlation to equity markets) and relatively less risk (market is already pricing in higher rates for longer), we believe it again makes sense to lengthen the duration (I.e. increase the sensitivity to interest rate changes) within the fixed interest part of the portfolio.

With the cumulative impact of tighter financial conditions posing risks to the economic outlook, we are keenly focused on risk-adjusted returns within fixed interest, but believe the spread on high-grade, liquid credit offers an attractive yield pick-up relative to government bonds given current credit spreads.

What we like about Western Asset

The Betashares Western Asset Australian Bond Fund ETF (ASX: BNDS), is managed by an experienced team operating within a specialised fixed interest group. The Australian team based in Melbourne, can leverage the global research capabilities of the broader group with offices in 5 other countries. The PM, Anthony Kirkham, is part of the Global Investment Strategy Committee which is a valuable input in setting macro and sector positioning.

The team implements a simple investment process designed to balance the defensive qualities of fixed interest (duration) with the ability to generate attractive monthly income (additional yield from credit). Duration levels are managed closely to a benchmark (+/- 1 yr vs. Bloomberg Ausbond Composite 0+ Yr Index), however, the mandate provides flexibility to allocate across Commonwealth Government, State Government, Supranational and Corporate Credit sectors.

Currently, the fund carries 5.5 years of duration, has a Yield to Maturity of 4.87%, and is broadly invested across government and investment-grade corporate bonds.

Conclusion

To conclude, across portfolios with a fixed income allocation, we added the Betashares Western Asset Australian Bond Fund ETF, funded by the sale of the iShares Treasury ETF and a reduction to the Janus Henderson Tactical Income Fund position. This increases portfolio sensitivity to changes in bond yields and slightly more income as the exposure to high-grade corporate credit provides higher yields relative to only holding government bonds. We continue to believe that fixed interest should be treated as a defensive exposure within portfolios, and that “active” fund managers are better placed to navigate the current volatile market environment. Following these changes, the Australian fixed interest component of portfolios is now neutral duration relative to its benchmark.

As always, thank you for your ongoing support, it is very much appreciated. If you have any questions or would like more information, please contact your adviser.

Warnings and disclosures

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