Total Return Perspectives: December 2020
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.
Review:
- 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
Outlook:
- 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.
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 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.
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