Published on May 5, 2020
While fiscal and monetary stimulus have stabilized markets, we believe continued economic weakness will stunt the performance of risk assets.
April 2020 Review:
- Markets broadly stabilized as fiscal and monetary stimulus programs began to take hold. The Federal Reserve has already begun to taper its official purchases in Treasuries and Agency MBS to a fraction of their original pace in mid-late March.
- Economic data is beginning to trickle in and reflects a profound and sudden recession, with job losses in the U.S. running in the tens of millions.
- In April the 10-year Treasury yield fell 7 basis points, from 0.69% to 0.62%. Treasuries returned 0.64%, bringing the year-to-date return to 8.89%.
- Corporate spreads recovered just under half of their March losses. The corporate sector outperformed duration-matched Treasuries by 455 basis points, as the option-adjusted spread of corporates narrowed 70 basis points to close April at 202 basis points. This level is still 80 basis points wider than it stood at the end of February.
- Mortgages posted another solid month, as the sector delivered 48 basis points of excess return versus duration-matched Treasuries. Mortgage spreads are largely in line with their pre-Covid levels.
- Buoyed by their outperformance versus Treasuries on a duration-adjusted basis, the Bloomberg Barclays U.S. Corporate and MBS indices each delivered positive absolute returns (5.24% and 0.64%, respectively). Mortgages have substantially shorter duration exposure than Treasuries.
- After increasing our allocation to Corporates in March and part of April, we have taken profits on these positions – mostly in the last week of April.
- The portfolio (+1.86%) outperformed the Bloomberg Barclays U.S. Aggregate Bond Index (+1.78%) in April, primarily due to its increased allocation to corporates, underweighting in Treasuries, and security selection within MBS.
Standardized performance can be viewed here: Monthly and Quarter End Performance
- The economic shutdown has paralyzed the global economy with only modest signs of a return to normalcy in the areas hit earliest. Coordinated central bank and government responses have injected liquidity and provided a temporary floor to asset prices but have not solved the cause of the downturn. We expect to see bleak data across the board for months to come.
- The markets have digested a deluge of corporate supply. However, against a backdrop of weak data with little recovery seen thus far, we expect spreads to widen and have since turned defensive in our positioning, including an increase in our allocation to Treasuries and a decrease to below-index weighting in corporates.
- We maintain an overweight to mortgages – specifically lower coupon mortgages that have less prepayment risk – while adding to our mortgage derivative exposure at very cheap levels, focusing on very seasoned collateral that is less sensitive to rate-induced prepayments. We maintain a somewhat elevated duration exposure, in the short term.
Chief Investment Officer – Total Return & Lead Portfolio Manager
Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.
Performance data quoted represent past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be higher or lower than the performance quoted. Performance data current to the most recent month end may be obtained by calling shareholder services toll free at (866) 236-0050.
The Bloomberg U.S. Aggregate Bond Index (BC Agg) is an unmanaged index which is widely regarded as the standard for measuring U.S. investment grade bond market performance. This index does not incur expenses and is not available for investment. The index includes reinvestment of dividends and/or interest income.
The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
The Bloomberg Barclays U.S. Corporate Index includes publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. The index includes exclusively corporate sectors, including Industrial, Utility, and Finance, which include both U.S. and non-U.S. corporations.
Sector returns above are those of the Bloomberg Barclays U.S. Aggregate Bond Index.
Mutual fund investing involves risk. Principal loss is possible. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities.”
A basis point is a unit that is equal to 1/100th of 1%.
Coupon is the interest rate stated on a bond when it’s issued. The coupon is typically paid semiannually.
Investment grade bonds are bonds with high and medium credit quality assigned by a rating agency. For Standard and Poor’s, investment grade bonds include BBB ratings or higher. For Moody’s, the cutoff is Baa.
A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.
Duration measures the sensitivity of a fixed income security’s price (or the aggregate market value of a portfolio of fixed income securities) to changes in interest rates. Fixed income securities with longer durations generally have more volatile prices than those of comparable quality with shorter durations.
The Federal Funds Rate is the rate at which depository institutions (banks) lend reserve balances to other banks on an overnight basis.
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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC.