Total Return Perspectives: June 2021
Published on July 7, 2021
Following the June Federal Open Market Committee (FOMC) meeting, the Treasury curve flattened as the market reacted to a more aggressive hiking schedule than previously expected. Risk continued to perform well as investment grade (IG) corporates outperformed again and tightened through levels not seen since 2018. Economic data continues to improve showing the reopening remains on track, but investors remain focused on elevated levels of inflation.
Review:
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) ended the month of June returning 0.70% for the period, the third consecutive positive monthly return. The Bloomberg Barclays U.S Corporate Index (+1.63%) continued to lead the major investment grade sectors as duration and spread tightening boosted returns. Treasuries (+0.64%) also continued their positive streak as the yield curve flattened. Mortgage backed securities (MBS) lagged (-0.04%) but showed signs of stability as spreads tightened during the last week of the month.
- Investors remained focused on upward moves in inflation indicators as well as the FOMC’s response to improvements in the economy. June headline CPI increased 5.0% year-over-year and core CPI increased 3.8%, higher than the Fed’s targeted level of 2.0%. The June FOMC Dot Plot showed that Fed policymakers expect two interest rate increases by 2023, pulling forward previous forecasts of an initial hike in 2024. Chairman Powell reiterated his view that current elevated levels of inflation are transitory. Going forward, investors will continue to study data for clarity on whether inflation will subside as temporary factors such as supply chain disruptions resolve or if pricing pressures broaden out with inflation being more persistent.
- The Treasury curve flattened as the market priced in a more aggressive Fed tightening timeline, suggesting that the Fed will be able to contain future inflation. The 2-year yield increased 11 basis points to 0.25%, the 5-year yield increased 7 basis points to 0.87%, while the 10-year yield fell 15 basis points to 1.44%, and the 30-year yield fell 22 basis point to 2.07%.
- The option-adjusted spread of the Corporate Index tightened another 4 basis points in June to 80 basis points. The corporate sector outperformed duration-matched Treasuries by 50 basis points.
- The Bloomberg Barclays U.S. MBS Index underperformed duration-matched Treasuries by 36 basis points as spreads for the sector widened 5 basis points during June. During the period, mortgage spreads got as wide as 74 basis points before tightening in the last week of June, leaving the sector with a spread of 67 basis points. Investors did get some relief as prepayment speeds continued to moderate during the month but the sector continues to grapple with various Fed governors expressing a desire to reduce MBS purchases.
- The fund (+0.05%) underperformed the BC Agg (+0.70%) in June. The underperformance is primarily attributable to a reduced duration profile.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- Given the level of Treasury yields and spreads, we remain focused on security selection, as we believe idiosyncratic factors particular to individual credits and mortgage securities will be the driver of outperformance. We reduced our exposure to corporates at the end of the month as spreads for the sector grinded to multi-year tights. But we continue to see value in individual credits exposed to the reopening. As for mortgages, we are looking at a variety of securities that should outperform as we expect the Treasury curve to steepen going forward. We continue to remain defensive on duration and also look for ways to take advantage as inflation continues at elevated levels, including buying Treasury Inflation-Protected Securities (TIPS), as recent declines in breakevens have presented opportunities.
Eddy Vataru
Chief Investment Officer – Total Return
John Sheehan
Vice President & Portfolio Manager
Daniel Oh
Vice President & Portfolio Manager
Featuring
Eddy Vataru
Chief Investment Officer – Total Return
Prior to joining Osterweis Capital Management in 2016, Eddy Vataru worked in senior management positions at Incapture, LLC and Citadel, LLC. Before that he spent over 11 years at BlackRock (formerly Barclays Global Investors, BGI), where his last position was as Managing Director and Head of U.S. Rates and Mortgages. While in this role, BGI worked with the U.S. Treasury in implementing its Agency MBS Purchase Program, buying mortgages for the U.S. government from 2008-2009.
He is a principal of the firm and the lead Portfolio Manager for the total return fixed income strategy. Mr. Vataru is also a Portfolio Manager for the growth & income and flexible balanced strategies.
Mr. Vataru graduated from California Institute of Technology (B.S. in Chemistry & Economics) and from Olin Business School at Washington University in St. Louis (M.B.A.). Mr. Vataru holds the CFA designation.
John Sheehan
Vice President & Portfolio Manager
Prior to joining Osterweis Capital Management in 2018, John Sheehan spent more than 20 years working at Citigroup, first as Managing Director responsible for Investment Grade Syndicate in New York City, where he advised issuers on accessing funding in the corporate bond market. Later at Citigroup, he was Managing Director in charge of West Coast Investment Grade Sales in San Francisco, where he covered several of the largest U.S. investment grade credit investors.
He is a principal of the firm and a Portfolio Manager for the total return fixed income strategy.
Mr. Sheehan graduated from Georgetown University (B.A. in Economics). Mr. Sheehan holds the CFA designation.
Daniel Oh
Vice President & Portfolio Manager
Prior to joining Osterweis Capital Management in 2018, Daniel Oh spent over eight years as a Director at Estabrook Capital Management in New York City and was the lead Portfolio Manager of the Estabrook Investment Grade Fixed Income Fund. Before that he was at Merrill Lynch & Co. as an Associate in Prime/Alt-A-Non-Agency Mortgage Trading. Prior to that, he held positions at Seneca Financial Group and Morgan Stanley.
Mr. Oh’s professional history includes experience in investment grade corporate credit, non-agency and whole loan mortgages, structured credit, and distressed investments.
He is a principal of the firm and a Portfolio Manager for the total return fixed income strategy.
Mr. Oh graduated from Columbia University (B.A. in Economics/Political Science) and from the Stephen M. Ross School of Business at the University of Michigan (M.B.A.).
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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 fund’s Gross Expense Ratio (as of 3/31/21) is 0.70%
The Bloomberg U.S. Aggregate Bond Index (Agg) is an unmanaged index that 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 U.S. 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.” The Osterweis Total Return Fund may invest in fixed income securities which are subject to credit, default, extension, interest rate and prepayment risks. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in foreign and emerging market securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used. Investments in preferred securities have an inverse relationship with changes in the prevailing interest rate. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in municipal securities which are subject to the risk of default.
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 (IG 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.
Spread is the difference in yield between a risk-free asset such as a U.S. Treasury bond and another security with the same maturity but of lesser quality.
Option-Adjusted Spread is a spread calculation for securities with embedded options and takes into account that expected cash flows will fluctuate as interest rates change.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
The producer price index (PPI) is a group of indices that calculates and represents the average movement in selling prices from domestic production over time.
The Job Openings and Labor Turnover Survey (JOLTS) program produces data on job openings, hires, and separations.
Treasury inflation-protected securities (TIPS) are a type of Treasury security issued by the U.S. government that are indexed to inflation in order to protect investors from a decline in purchasing power.
It is not possible to invest in an index.
All investments involve risk. Principal loss is possible. Treasury notes are guaranteed by the U.S. government and thus they are considered to be safer than other asset classes.
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