PM Capital Enhanced Yield B (PMC4700AU) Report & Performance

•Fixed rate bond investments drive returns for July
•Aurizon and Micron were key contributors to performance
•Current -5.5% gross yield to maturity” gives us plenty to smile about

The Fund began the new financial year well, primarily as a result of our fixed interest rate bond exposures.

Interest rate markets rallied strongly in July, reflecting a material shift in expectations, as softer inflation and weaker consumer data prompted investors to consider that many of the world’s major central banks are towards, or even at the end of their tightening cycles.

This was reflected in rhetoric from the US Federal Reserve, the European Central Bank and the Reserve Bank of Australia, who all flagged that from here on, any future rate rises will only occur if warranted by economic data.

From a credit perspective, our holding in Australian energy infrastructure business Aurizon performed well as the market started to recognise its strong position in the resources value chain and improving earnings.

Additionally, our holding in the bonds of global memory technology powerhouse Micron performed well on strong earnings, driven by increasing demand from the surging artificial intelligence sector.

Our significant recent investing at what we consider attractive yields has delivered pleasing performance and we believe we have a good platform to work from for the next couple of years.

• Pleasing performance for the month and the year despite substantial rises in market interest rates
• Major bank and Spanish property bonds deliver outsized returns in June despite the volatility
• Yield to maturity of portfolio close to 12 month high at ~5.50%^

June was a solid month for performance, despite 3-year bond yields rising by ~0.70% and 10-year yields rising by ~0.40%. Performance for the year to June was also solid at 5.4% after fees.

Performance was buoyed by a number of positive developments for some of our existing holdings.

Our holding in long dated US dollar (hedged back to Australian dollar) floating rate bonds issued by ANZ and Westpac rallied significantly after CBA announced it was redeeming a similar bond. In light of the step change in valuation, we were happy to sell our holding, having generated a return of ~8% p.a. from this investment.

Additionally, our holding in the senior secured bonds of Spanish property company Aedas rallied strongly as speculation mounts regarding a potential takeover by existing major shareholder Castlelake. In order to access the cashflow from the secured properties, Castlelake would currently need to redeem the bonds at a premium.

We are content to wait and see what transpires here. Despite the rally, the bonds currently generate a yield of ~7.50% which we still see as an attractive return for the level of risk, and thus we are happy to hold the investment for the time being.

We are pleased with the performance of the Fund over the past year. Interestingly though, due to the considerable amount of investing we have done, the gross yield to maturity of the portfolio is actually closer to its 12 month high at ~5.50%^

Interest rate hedges help protect investor capital amid sharp rises in bond yields

Higher bond yields subsequently provide opportunities to lock in further returns.

Bond yields rose notably over the month as investors turned their attention from bank balance sheets, back to inflationary pressures and the potential for higher official interest rates near term.

The Fund absorbed the rate increases well, as it had a significant amount of its interest rate exposure hedged during the move. We have now lifted the hedge, with expectations that any future increase in rates will be somewhat more modest.

We invested just under 10% of the Fund’s capital during the month in the senior bonds of a number of new and existing issuer names such as Woolworths, Apple and US memory and storage giant Micron, at yields of up to ~6%.

While there is no doubt that there is still upward pressure on inflation evident in some sections of the economy, there are also signs that activity is starting to moderate. With markets now factoring in an RBA cash rate comfortably above 4% near term, we are happy to lock in bond yields to maturity along the lines of those above.

The Fund still has a substantial amount of spare capital on hand, and thus we are in an excellent position to take advantage of further compelling yield opportunities as they become available.

Bond market valuations fluctuated over the month, as investors tried to get a handle on where global central banks were at with their respective tightening cycles. The consensus seems to be that most are near the end. In response to the banking sector issues that ensued in March/April, bond market investors began to price in substantial interest rate cuts – in some cases this year. With a heavy inflation backdrop and a strong labour market we felt this was premature.

At one point Australian 3 year bonds were pricing in a ~2% RBA cash rate over the next couple of years which we felt was far too aggressive. Hence, we closed out the majority of the Fund’s exposure to fixed interest rates, locking in substantial gains. Bank subordinated bonds performed well during the month.

In particular the Fund’s holding in US dollar (hedged into Australian dollar) floating rate bonds issued by ANZ and Westpac performed well, after global banking giant HSBC redeemed a similarly natured bond, prompting market speculation that ANZ and Westpac may do the same. The ongoing benefits accumulating from the considerable increase in the Fund’s yield to maturity was the other main driver of performance in April. With the large amount of investing that we have done over the past year, the underlying yield from these bonds is now creating a good starting point month to month.

The March quarter was eventful to say the least – with central banks around the world battling to get inflation under control – and then more recently, several lower tier offshore banks succumbing to a mix of large reductions in their asset values, coinciding with material deposit outflows from their customers – ultimately requiring them to rely on central bank or government funding support – and in the case of Credit Suisse – requiring a complete transfer of ownership to Swiss banking giant UBS. (The Fund had no direct exposure to any of these banks)

We are pleased to report that the Fund not only preserved investor capital over the quarter, but generated a positive return of 1.9%.

• Major bank bonds get a lift from increasing interest rate expectations
• European property and industrial services companies provide healthy returns on capital restructuring
• Tesco bonds outperform as the business delivers strong earnings growth

February was a month of contrasts, with different sectors moving in different directions as global central banks surprised investors with somewhat hawkish tones, suggesting that there may be more interest rate rises on the horizon than first thought.

The Fund’s holding in major bank subordinated bonds performed well, as the potential for higher interest rates in the near to medium term suggests better earnings outcomes for the banks.

Our holdings in the senior secured bonds of Spanish property companies Aedas and Neinor Homes also performed well, after Neinor announced an on-market buyback of its bonds at well above market price. While we didn’t sell into the buyback, we made significant mark-to-market gains. Aedas’s bonds rallied on the expectation that it might do the same.

French industrial services company SPIE redeemed its 2024 maturity bonds – also at a significant premium to market – which added meaningfully to recent performance.

The Fund’s holding in Tesco’s senior secured bonds rallied significantly as it reported strong quarterly earnings, driven by several categories including fresh food sales and strong growth in online sales.

We made new and additional investments during the month, including increases to our positions in the senior bonds of fuel distribution company Ampol, and US banking giant Wells Fargo at yields of ~5%.

With the considerable amount of investing that the Fund has done recently, the gross yield to maturity of the Fund now sits at greater than 5%^.