Published on September 23, 2020

Bob Veres of Insider’s Forum recently moderated a panel discussion featuring Eddy Vataru, lead portfolio manager of the Osterweis Total Return Fund (OSTRX), that explored the apparent disconnect between the strength of the bond market and the weakness of the macroeconomy. As Bob writes in his recap:

“Everybody is wondering how the stock market can be so high while the U.S. economy is so low. But you don’t hear the same rumbling concerns about the bond market – even though something very similar to ultra-high P/Es is going on in the fixed income side of your portfolio.”

To be more specific, the average yield on the Bloomberg Barclays Aggregate Index (BC Agg) is just over 1% while the duration is about 6, which means a 1% increase in interest rates would cause the value of the index to fall roughly 6%. Assuming the current ~1% yield, it would take nearly 6 full years to recover those losses. In other words, the risk/reward profile of the BC Agg is at an all-time low.

Eddy started off the panel discussion by explaining that the current predicament is largely a byproduct of the monumental stimulus programs implemented by the Federal Reserve (the Fed) in response to the Covid-19 pandemic. Not only is the size of the latest quantitative easing (QE) cycle unprecedented – the Fed has increased its balance sheet by a staggering $3 trillion in the past few months – but the scope of the program has also expanded as the Fed now buys corporate debt directly. Previous QE purchases were limited to Treasuries and mortgages, both of which were also included in the current program.

The historic support from the Fed has done more than simply stabilize the bond market – it has triggered an equity rally and a concurrent decline in credit spreads for corporate issuers. This has had the dual effect of dropping yields in the index and simultaneously washing out the risk that the pandemic has introduced. In fact, corporate spreads have nearly returned to their pre-pandemic levels, which were near all-time tights. Eddy said those levels may be too optimistic given the circumstances:

“The spreads are pretty stunning when you think about the fact that we haven’t solved for the virus, we don’t have a vaccine, we don’t have any therapeutics, and we have some pretty listless companies now whose business models are quite compromised as they navigate the patchwork of shutdowns we’ve had nationwide.”

The discussion pivoted to strategies for managing fixed income in the current environment, as it is challenging to find meaningful returns with yields hovering near all-time lows. Eddy explained his approach, which includes rotating among sectors, as there historically is substantial dispersion among Treasuries, corporates, and mortgages with the investment grade universe. His fund is currently significantly overweight mortgages, slightly overweight corporates, and significantly underweight Treasuries.

To read the full text of Bob’s recap, which is published on Advisor Perspectives, click here.


Eddy Vataru

Chief Investment Officer – Total Return

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.

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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.

Credit ratings are from Moody’s, which is a private independent rating service that assign grades to bonds to represent their credit quality. The issues are evaluated based on such factors as the bond issuer’s financial strength, or its ability to pay a bond’s principal and interest in a timely fashion. Moody’s ratings are expressed as letters and numbers ranging from ‘Aaa’, which is the highest grade, to ‘C’, which is the lowest grade, and may include expected ratings. A Moody’s rating of Baa3 or higher is considered investment grade while those below Baa3 are considered non-investment grade. A rating of Aaa is assumed for Freddie Mac, Fannie Mae, and Ginnie Mae securities.

Price-to-Earnings (P/E) ratio is the ratio of the stock price to the trailing 12 months diluted EPS.

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.

Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.

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.

A basis point is a unit that is equal to 1/100th of 1%.

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.

The Troubled Asset Relief Program (TARP) was an initiative created and run by the U.S. Treasury to stabilize the country’s financial system, restore economic growth, and mitigate foreclosures in the wake of the 2008 financial crisis. TARP sought to achieve these targets by purchasing troubled companies’ assets and stock.

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