Bond portfolio: Grid and income rescues performance

I have hesitated to update the bond portfolio during the height of the eurozone crisis, given the portfolio's holding in the eurozone high yield bond ETF.

After a few calmer weeks in the market, however, fundamentals appear to have reasserted themselves, some dividends and interest has been paid and performance looks a little better than it did.

The National Grid inflation-linked retail bond added shortly after its issue last October has contributed solidly to the portfolio's performance and now shows a gain of 2.4%. A gain like this is a big deal for a bondholder. Even the eurozone high yield bond ETF is currently showing a small capital profit, despite recent weakness in the currency in which it is denominated.

One of the key contributors to the portfolio's performance has been a half-yearly dividend from the General Accident preference stock, paid on New Year's Day. This dividend, £110.93, has been supplemented by a modest payment from the short gilt ETF in the portfolio. This payment, only some £18, will be paid on 25 January, but I have credited it now, as the amount is small and the fund has already gone ex-dividend. Both payments have been added to the cash balance of the portfolio.

As the table shows, the portfolio is up around 0.7% overall since inception versus a gain over the same period of 1.7% in the IMA £ Corporate Bond Sector, our best chosen benchmark.

I am planning on making some small adjustments to the portfolio to improve its yield. One is to sell half of the holding in the short gilt iShare. This produces around £1,300 after allowing for dealing costs which, added to the existing cash balance in the portfolio, gives a total of £1,679 to be invested in another stock.

I am using most of this cash to add a holding in the Co-operative Bank 5.5555% perpetual subordinated bond, which currently stands at 67.25% of face value. This stock is irredeemable in most circumstances, but in theory could be called for redemption in December 2015 at 100.

If this happened the yield to maturity on the stock would be a whopping 17%. The chances are that it won't happen, since it would cost the Co-op £200 million to do so.

In the meantime, however, the yield on the bonds coupon is around 8.2%. This would fall to LIBOR + 2% if the bond is not repaid in 2015. This seems to me to represent a good balance of returns. If interest rates rise, as they may have to do by 2015, then the subsequent yield will be higher and the bond will in effect become a floating rate note. If it is called, the return will be sizeable, and in the short term the yield on the bond is better than most others on offer.

So I'm buying £2,000 nominal of the stock at the current price of 67.5 and a cost of £1,350. After allowing for dealing costs, that leaves cash balances at around £320.