Total Return Perspectives: September 2021
Published on October 6, 2021
U.S. Treasury yields continued to rise during September as the Federal Reserve prepared markets for an eventual tapering of its quantitative easing program and inflation data remained elevated. Corporate bond spreads were resilient despite the rise in equity volatility.
Review:
- The Bloomberg U.S. Aggregate Bond Index (BC Agg) returned -0.87% in September, extending losses from the previous month. Treasuries (-1.08%) were the worst performing investment grade sector as yields increased across the curve. The Bloomberg U.S. Corporate Index (-1.05%) also had a difficult month as the sector remains exposed to higher rates due to its longer duration profile. Mortgage-backed securities (MBS) (-0.36%) performed the best as they benefited from a shorter duration and tighter spreads.
- The latest headline CPI came in at 5.3% year-over-year (with core CPI at 4.0%), which was slightly lower than last month but still well in excess of the Fed’s 2.0% long-term target. Investors continue to hear reports from corporations describing elevated costs due to supply disruptions and labor shortages, creating margin pressure and forcing some to raise prices. It appears that the current inflationary cycle may remain in play for longer than initially anticipated.
- Treasury yields rose across the maturity spectrum as the market readjusted expectations for a tapering of quantitative easing. The 2-year yield rose 8 basis points to 0.29%. The 5-year yield increased 22 basis points to 0.99%. The 10-year yield climbed 23 basis points to 1.53%, and the 30-year yield increased 16 basis points to 2.09%.
- The option-adjusted spread of the Corporate Index tightened 3 basis points in September to 84 basis points and is now only 4 basis points wide of the year-to-date tights. Investment grade corporate spreads remained resilient despite heavy issuance (over $158 billion in September) and elevated equity volatility.
- The Bloomberg U.S. MBS Index outperformed duration-matched Treasuries by 24 basis points as spreads for the sector tightened 5 basis points in September.
- The fund (-0.35%) outperformed the BC Agg (-0.87%) in September. The outperformance is attributable to the shorter duration profile and lower exposure to Treasuries in addition to the spread tightening in both corporate and mortgage sectors.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- We remain defensive with a lower duration profile as we continue to believe that elevated inflation levels will be more persistent than what is currently being recognized by the market. We have trimmed some of our corporate names based on valuation, although we are optimistic about the sector as cases of the Delta variant continue to fall. We will look to add to our corporate position as opportunities present themselves.
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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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 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 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 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 (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.
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