Published on December 3, 2020
In November Treasury yields fell slightly, mostly concentrated in longer maturities. Corporate bond spreads narrowed sharply, paced by strong appetite for risk assets that began after election day. We also appear to be substantially closer to dissemination of a vaccine against Covid-19.
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted a strong return in November, rising 98 basis points. The majority of this return stemmed from significant tightening in corporate spreads, which propelled the Corporate sector (+2.79%) to its best return since July. Treasuries (+0.35%) and MBS (+0.07%) both trailed the overall Aggregate return.
- Economic data continued to reflect improvement in the economy, mostly in employment and housing indicators. The job picture continued to brighten as unemployment fell to 6.9%. Housing starts and home sales continued to post heady gains, benefiting from low mortgage rates. Inflation measures stalled, as CPI was unchanged for the month of October. Consumer sentiment and retail sales indices showed tepid improvement, which slowed from the prior month.
- The Treasury curve paused its three-month bear steepening run. The 5-year and 10-year Treasury yields each fell 2 basis points to 0.36% and 0.84%, respectively, while the 30-year yield dropped nearly 7 basis points to 1.57%.
- Corporate spreads took a run at pre-pandemic levels in November. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index narrowed 21 basis points, ending the month at 104 basis points. The corporate sector outperformed duration-matched Treasuries by an impressive 233 basis points.
- The Bloomberg Barclays U.S. MBS Index trailed duration-matched Treasuries by 1 basis point. Mortgage durations remained extremely low, owing to the moneyness of most of the index given the fall in mortgage rates. It should be noted that lower/current coupon MBS (like 30-year FNMA 2%) substantially outperformed the higher coupon issues that comprise the majority of the index. Current coupon MBS spreads tightened 6 basis points to 73 basis points.
- The fund (+1.24%) outperformed the BC Agg (+0.98%) in November. Most of this outperformance is attributable to our overweight to corporates and security selection in this sector as well as our underweight to Treasuries.
Standardized performance can be viewed here: Monthly and Quarter End Performance
- Risk markets reacted favorably to an election outcome that appears to be a gridlocked Congress (Republican Senate, Democratic House). A blue wave would have likely paved the way for the largest possible fiscal stimulus package – coupled with increased Treasury issuance and higher taxes. If Republicans win either of the two Senate runoff elections in Georgia in January, this scenario is unlikely.
- 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 somewhat 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. Longer term, we do believe interest rates will rise – perhaps substantially – and will look to protect the portfolio by employing a shorter interest rate duration than our benchmark.
- We are much closer to a resolution to the virus than we were a month ago, although we seem to be facing several dark weeks ahead as the spread has intensified. We are more focused on the light at the end of the tunnel and believe any weakness in economic data or activity that may be observed in the coming month or two will be short-lived.
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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 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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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20201102-0056]