Total Return Perspectives: July 2020
Published on August 6, 2020
Monetary stimulus continued to dominate in July, as both risk assets and Treasuries performed well. Despite the resurgence of Covid-19 and the expiration of enhanced unemployment benefits, the market remained stable due to ongoing support from the Federal Reserve.
Review:
- Assets across the spectrum performed well during the month as spreads tightened in the risk space and Treasury yields decreased. The Federal Reserve remained active in their purchasing activities and extended various lending facilities to end-of-year.
- The improvement in economic data moderated in July as surges in Covid-19 around the country tempered the recent recovery in various indicators.
- The Treasury curve flattened over the month as yields on the long end of the curve decreased more than shorter rates. In July, the 30-year Treasury yield fell 21 basis points, from 1.41% to 1.20%, while the 5-year Treasury yield fell only 7 basis points, from 0.29% to 0.22%. The bid for Treasuries remained robust over the month as uncertainties increased and the Federal Open Market Committee reaffirmed their dovish stance.
- Corporate spreads continued to tighten towards pre-pandemic levels. The option-adjusted spread of the sector narrowed 17 basis points, ending the month at 133 basis points, which is within striking distance of the level seen at the end of February (122 basis points). The corporate sector outperformed duration-matched Treasuries by 177 basis points.
- Mortgages slightly lagged duration-matched Treasuries by 2 basis points as prepayment speeds remained elevated, resulting in continued underperformance of higher coupon MBS. Demand for lower coupon MBS remained strong as investors looked for prepayment protection.
- The fund (+1.20%) trailed the Bloomberg Barclays U.S. Aggregate Bond Index (+1.49%) in July. The fund lagged primarily due to its duration stance, with less exposure to interest rates than the index.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- The economic recovery has taken a pause as the coronavirus has surged in several areas of the country. We continue to observe the divergence between the performance of risk markets and the continued rise in Covid-19 cases. As stated previously, we find the support in the form of monetary and fiscal policy to be the main driver of this divide. As such, we continue to view our exposure to spread product as appropriate at this time. Yet we continue to believe security selection will remain paramount as we manage both the mortgage and corporate books.
- Corporate spreads further tightened during the month, and we believe that this trend will continue. The technical setup remains conducive to further tightening as inflows into the investment grade bond asset class remains robust and new issuance of corporate bonds will be a fraction of what was underwritten during the first half of the year. Corporates spreads remain wide of levels prior to the pandemic and have the additional backstop of the Federal Reserve’s corporate bond purchases. As such, we remain constructive on this sector.
- Going forward, we remain overweight mortgages – with a continued focus on lower coupon mortgage pools and mortgage derivatives off very seasoned collateral. We will also look to opportunistically add to our corporate bond holdings as we reduced our exposure during June when certain bonds reached our target levels.
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 3/31/20) is 0.67%
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.
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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.
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