Published on November 5, 2020

In October Treasuries resumed a steady rise in yields that began in August. Corporate and mortgage bond spreads narrowed, despite weakness in risk sentiment seen in equity markets. Although the election remains undecided, the bond market has rallied as investors are expecting a divided Congress – implying a smaller fiscal stimulus package and continued monetary support from the Fed.

Review:

  • The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted its third consecutive negative return in October, falling 45 basis points. U.S. MBS (+0.03%) delivered the best return, outpacing corporates (-0.14%) and Treasuries (-0.94%) for the month.
  • Economic data continued to reflect improvement in the economy. The job picture improved as unemployment fell to 7.9%. PPI surprised slightly to the upside (+0.4% vs 0.2% expected) but headline CPI was in-line at +0.2%. Consumer sentiment indices also showed improvement, and housing starts and home sales continue to be strong. Finally, third quarter GDP posted a heady gain of 33.1%, reversing most of the loss seen during the second quarter.
  • The Treasury curve resumed the bear steepening trend seen in August. The 5-year Treasury yield rose 11 basis points to 0.38%, the 10-year Treasury yield rose 18 basis points to 0.86%, and the 30-year Treasury yield also rose 18 basis points to 1.64%.
  • Corporate spreads resumed their march down to pre-pandemic levels. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index narrowed 11 basis points, ending the month at 125 basis points. The corporate sector outperformed duration-matched Treasuries by 99 basis points.
  • The Bloomberg Barclays U.S. Mortgage Backed Securities Index outperformed duration-matched Treasuries by 12 basis points. Mortgage durations are extremely low, owing to the moneyness of most of the index given the fall in mortgage rates. On an absolute basis, MBS posted the highest return of the major investment grade sectors.
  • The fund (-0.08%) outperformed the BC Agg (-0.45%) in October. Most of this outperformance is attributable to our overweight to MBS and corporates and underweight to Treasuries, as well as our slightly shorter duration profile than the benchmark.

Standardized performance can be viewed here: Monthly and Quarter End Performance

 

Outlook:

  • In the first week of November, risk markets reacted favorably to what appears to be a gridlocked Congress (Republican Senate, Democratic House). The bond market also reacted favorably since the likelihood of a blue wave (Democratic sweep of Presidency, Senate, and House) has dissipated.
  • A blue wave would have likely paved the way for the largest possible fiscal stimulus package, which itself would likely stoke inflation and increase Treasury issuance. In addition, it would also feature the highest likelihood of significant tax increases, which would hurt risk assets (in particular, equities and corporate bonds).
  • A gridlocked Congress, regardless of the winner of the presidential race, would yield the smallest stimulus package, and leave the current tax code intact. The first two days of trading after the election have seen interest rates fall and risk assets (equities, corporate bonds, and MBS) all perform well as this appears to be the consensus outcome.
  • The greatest uncertainty in the forecast is whether the Republicans will retain the senate, as Georgia seems to be headed to at least one runoff election in January. At this point, it seems we will not have a clear picture until then, although Republicans are favored to win a runoff in Georgia at this time.
  • If the consensus election forecast holds and Republicans retain the senate – a view we share – we continue to favor an overweight to corporate bonds and current coupon MBS. In this scenario we see a delayed rise in Treasury rates and believe the Fed may be compelled to increase its quantitative easing program if it feels the potential fiscal stimulus package that could be offered is insufficient to stoke an economic recovery.
  • If the possibility of a blue wave were to rise, we would be much less constructive on corporate credit and interest rates. Further, current coupon MBS could suffer if a rate selloff were to trigger originator selling and convexity hedging.
  • Against this election uncertainty, any change in the trajectory of the pandemic will also have a secondary effect on fixed income markets. Increases in cases, hospitalizations, and deaths (a second wave) will likely hurt risk assets (wider spreads) and trigger a Treasury rally. Any development of a vaccine or improvement in health outcomes related to the virus will be positive for risk (tighter spreads) but could see interest rates rise on the prospect of a more robust economy (and thus less Fed stimulus).

 

Eddy Vataru

Chief Investment Officer – Total Return

John Sheehan

Vice President & Portfolio Manager

Daniel Oh

Vice President & Portfolio Manager

Written by

Eddy Vataru

Chief Investment Officer – Total Return

Eddy Vataru

Chief Investment Officer – Total Return

Eddy Vataru graduated from California Institute of Technology (B.S. Chemistry & Economics) and from Olin Business School at Washington University in St. Louis (M.B.A.). Mr. Vataru holds the Chartered Financial Analyst designation.

Prior to joining Osterweis Capital Management in 2016, Mr. 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), 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.

Over the course of his career as a fixed income investor, Mr. Vataru has developed extensive experience in managing passive, active and hedge fund portfolios.

Mr. Vataru is a principal of the firm and the lead Portfolio Manager for the total return fixed income strategy. He is also a Portfolio Manager for the flexible balanced strategy.

John Sheehan

Vice President & Portfolio Manager

John Sheehan

Vice President & Portfolio Manager

John Sheehan graduated from Georgetown University (B.A. Economics). Mr. Sheehan holds the Chartered Financial Analyst designation.

Prior to joining Osterweis Capital Management in 2018, Mr. 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.

Mr. Sheehan is a principal of the firm and a Portfolio Manager for the total return fixed income strategy.

Daniel Oh

Vice President & Portfolio Manager

Daniel Oh

Vice President & Portfolio Manager

Daniel Oh graduated from Columbia University (B.A. Economics/Political Science) and from the Stephen M. Ross School of Business at the University of Michigan (M.B.A.).

Prior to joining Osterweis Capital Management in 2018, Mr. 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, whole loan mortgages, structured finance and distressed investments.

Mr. Oh is a principal of the firm and a Portfolio Manager for the total return fixed income strategy.

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The Morningstar Rating for funds, or “star rating,” is calculated for mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period has the greatest impact because it is included in all three rating periods.

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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 Barclays U.S. Aggregate Bond Index (BC Agg) is an unmanaged index which 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.

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.

It is not possible to invest in an index.

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