Total Return Perspectives: September 2020
Published on October 2, 2020
Treasuries were little changed in a month that saw yields confined to a very narrow range. Corporate and mortgage bond spreads widened slightly, consistent with the slight decline in equities and the uptick in equity volatility.
Review:
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted its second consecutive negative return in September, falling 5 basis points. Treasuries returned +0.14%, outperforming MBS (-0.11%) and corporates (-0.29%) for the month.
- Economic data continued to reflect improvement in the economy, as unemployment fell sharply. CPI posted another strong print (+0.4%) but it remains to be seen if two months of strong inflation prints are the beginning of a trend.
- The Treasury curve was little changed as yields across the maturity spectrum moved less than 2 basis points. The 5-year Treasury yield rose 1 basis point to 0.27%, the 10-year Treasury yield fell 2 basis points to 0.67%, and the 30-year Treasury yield was unchanged at 1.45%. The lack of rate volatility was a notable departure from the price action seen in August.
- Corporate spreads paused their march down to pre-pandemic levels. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index widened 7 basis points, ending the month at 136 basis points. The corporate sector underperformed duration-matched Treasuries by 40 basis points.
- The Bloomberg Barclays U.S. Mortgage Backed Securities Index underperformed duration-matched Treasuries by 14 basis points. Lower coupon MBS were the best performers, although these are still a very small part of the index. Demand for lower coupon MBS remained strong as investors continued to look for prepayment protection in an effort to “follow the Fed”; we expect this trend to continue.
- The fund (-0.05%) tracked the BC Agg (-0.05%) in September.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- Markets are in a bit of a holding pattern as virus headlines are replaced by focus on the upcoming election. As votes are beginning to be cast in the election, investors seem to have squared up their positions as trading volumes and volatility have declined. Corporate and mortgage spreads edged slightly wider in September and will continue to be influenced by election projections and the impact various potential outcomes could have on markets.
- Our view on corporate bonds is little changed. Supply in September exceeded our expectations and contributed to their observed underperformance. However, we feel corporate spreads are still sufficiently wide relative to their pre-pandemic levels to justify an over-weight, and we remain constructive on the sector.
- We also 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 has 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.
- We also see value in the non-agency prime mortgage space. During the month, a steady flow of new issuance in the sector continued as three deals hit the market. We remain focused on senior pass-throughs with low gross weighted average coupons. They remain attractive as there is a yield pickup against higher coupon agency mortgages and short duration corporates. Deals have been well received with strong demand for new issues so pricing continues to tighten.
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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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.
A mortgage TBA serves as a contract to purchase or sell an MBS on a specific date, but it does not include information regarding the pool number, number of pools, or the exact amount that will be included in the transaction.
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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