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.
- 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
- 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.
Chief Investment Officer – Total Return & Lead Portfolio Manager
Vice President & Portfolio Manager
Vice President & 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 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.
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 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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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC.