Total Return Perspectives: August 2020
Published on September 3, 2020
Treasuries took a breather in August as inflation fears gripped the market. Corporate and mortgage bond spreads held firm despite the lack of agreement on continued fiscal stimulus.
Review:
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted its first negative return since March, as the Treasury rally stalled on rising inflation fears. In his Jackson Hole speech, Federal Reserve (Fed) chairman Jerome Powell highlighted a change in the Fed’s inflation targeting policy, specifically aiming to overshoot their long-standing 2% target for a period of time to make up for shortfalls over the last few years.
- Economic data largely reflected continued improvement in the global economy. Notably, both PPI and CPI surged in July. The increase in Core CPI was the largest one-month rise since 1991, and completely reversed the decline seen this April.
- The Treasury curve steepened as yields on the long end of the curve increased more than shorter rates. In August, the 30-year Treasury yield rose over 25 basis points, from 1.20% to 1.45%, while the 5-year Treasury yield rose only 5 basis points, from 0.21% to 0.26%. The 10-year Treasury yield rose 16 basis points to 0.69%. All of these moves reversed the bull flattening observed in July.
- Corporate spreads continued to tighten towards pre-pandemic levels, albeit at a much slower pace. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index narrowed 4 basis points, ending the month at 129 basis points. The corporate sector outperformed duration-matched Treasuries by 5 basis points.
- The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index outperformed duration-matched Treasuries by 9 basis points. While prepayment speeds remain elevated, this seems to have been fully priced into the MBS market. Demand for lower coupon MBS remained strong as investors looked for prepayment protection.
- The fund (-0.28%) outperformed the BC Agg (-0.81%) in August. The fund benefitted from its shorter duration stance - with less exposure to interest rates than the index – as well as its overweight to mortgages and favorable security selection in corporates.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- Risk markets performed admirably despite the lack of agreement on a fiscal stimulus package. Corporate and mortgage spreads continued to narrow in conjunction with improved economic data. The inflation bump seen in July’s data is likely a short-term phenomenon attributable to dollar weakness and a rise in commodity and oil prices, but we are monitoring more persistent drivers of inflation in the months and years to come.
- Our view on corporate bonds is little changed. Spreads tightened further in August, and we believe that this general trend will continue. The technical setup remains conducive to further tightening as inflows into the investment grade bond asset class remain robust and new issuance of corporate bonds will be a fraction of what was underwritten during the first half of the year. At the index level, corporate spreads remain about 7 basis points wide of levels prior to the pandemic and have the additional backstop of the Federal Reserve’s corporate bond purchases, which have continued at a slower pace. As such, we remain constructive on this sector.
- Going forward, we remain overweight mortgages – with a continued focus on lower coupon mortgages and mortgage derivatives off very seasoned collateral. The Fed has purchased over $1 trillion in Agency MBS as part of QE4 and have indicated they plan to continue purchases into next year. The composition of our mortgage TBA position mirrors the portion of the Agency MBS market that the Fed is actively purchasing.
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.
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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.
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.
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