Published on January 6, 2021
In December Treasury yields mostly edged higher, concentrated in longer maturities. Corporate bond spreads narrowed, as investors maintained their appetite for risk assets. While we are closer to widespread dissemination of a vaccine against Covid-19, recent virus data and new lockdowns present a more somber view as the year begins.
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted a small gain in December, rising 14 basis points. The majority of this return stemmed from significant tightening in corporate and mortgage spreads. The corporate index (+0.44%) and MBS index (+0.22%) both outperformed Treasuries (-0.23%).
- Economic data continued to reflect some improvement in the economy. The headline unemployment rate fell 0.2% to 6.7%. Housing starts and home sales remained strong, benefiting from low mortgage rates. Inflation measures remained subdued for a third consecutive month.
- The Treasury curve resumed its bear steepening pattern, now seen in 4 of the last 5 months. The 5-year yield was unchanged at 0.36%, while the 10-year yield rose 8 basis points to 0.92% and the 30-year yield rose 8 basis points to 1.65%.
- Corporate spreads reached pre-pandemic levels at the beginning of November. The option-adjusted spread of the Bloomberg Barclays U.S. Corporate Index narrowed 8 basis points in December, ending the month at 96 basis points. The corporate sector outperformed duration-matched Treasuries by 79 basis points. Despite the massive interruption to the economy caused by the pandemic, corporate bond spreads widened only 3 basis points for the year.
- The Bloomberg Barclays U.S. MBS Index outperformed duration-matched Treasuries by 22 basis points. Mortgage durations remained extremely low, owing to the moneyness of most of the index given the fall in mortgage rates. Lower coupon MBS (like 30-year FNMA 2%) continued to perform well, supported by Fed purchases. Current coupon MBS spreads tightened 2 basis points to 70 basis points, nearly their tightest levels of the year.
- The fund (+0.66%) outperformed the BC Agg (+0.14%) in December. Most of this outperformance is attributable to our interest rate hedges and security selection within the corporate section. Our overweight to corporates, underweight to Treasuries, and security selection within MBS continued to support outperformance as well.
Standardized performance can be viewed here: Monthly and Quarter End Performance
- We enter the new year with risk assets priced to perfection. To sustain these levels, Fed stimulus must continue unabated. Monetary stimulus would also be a welcome tailwind, and the spread of the virus needs to decelerate.
- While we continue to favor a slight overweight to corporate bonds and MBS, we have trimmed our positions in both sectors and have added to our Treasury holding – purely on valuation concerns. Near-term risks include fallout from the elections (national and Georgia), continued vaccine distribution challenges, broader and more draconian lockdowns, and a wider spread of the newly discovered (and more contagious) form of Covid-19.
- Looking past the near term, we still believe any weakness in economic data or activity that may be observed this winter 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.
All investments involve risk. Principal loss is possible. Treasury notes are guaranteed by the U.S. government and thus they are considered to be safer than other asset classes.
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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20210105-0100]