Published on June 2, 2020
Fiscal and monetary stimulus have stabilized markets. Looking ahead we believe risk assets could continue to outperform Treasuries despite potentially weak economic data, largely due to Fed purchases.
May 2020 Review:
- Risk assets continued to perform well after the bottom in late March, as fiscal and monetary stimulus programs have supported markets and we begin to emerge from the depth of the economic trough. The Federal Reserve continues to taper its official purchases in Treasuries and Agency MBS to a fraction of their original pace in mid-late March.
- Economic data reveals slight improvement off lows in late March/early April.
- In May the 10-year Treasury yield rose 2 basis points, from 0.62% to 0.64%. However, the Treasury curve steepened noticeably, as the 5/30 spread steepened 18 basis points. The 5-year yield fell 5 basis points to 0.30%, while the 30-year yield rose 13 basis points to 1.40%. Treasuries returned -0.25%, bringing the year-to-date return to 8.61%.
- Corporate spreads continued to fall toward their pre-pandemic levels. The corporate sector outperformed duration-matched Treasuries by 181 basis points, as the option-adjusted spread of corporates narrowed 28 basis points to close May at 174 basis points. This level is just 52 basis points wider than it stood at the end of February.
- Buoyed by their outperformance versus Treasuries on a duration-adjusted basis, the Bloomberg Barclays U.S. Corporate and MBS indices each delivered positive absolute returns (1.56% and 0.12%, respectively). Mortgages generally maintain substantially shorter duration exposure than Treasuries, and likely benefited from the steepening of the yield curve (as their partial duration exposure tends to lie in the middle of the curve, not the 20-30 year point).
- The portfolio (+0.42%) tracked the Bloomberg Barclays U.S. Aggregate Bond Index (+0.47%) in May. While security selection within MBS helped performance, the overweight to longer Treasuries within our Treasury allocation detracted, leaving the overall fund return basically in-line with the index.
Standardized performance can be viewed here: Monthly and Quarter End Performance
- The economic downturn has moderated somewhat, as we have seen modest reopening of economies globally. We appear to have averted the worst health outcomes that were forecasted 2-3 months ago.
- Nevertheless, some parts of the risk market (equities) have noticeably decoupled from the underlying data (unemployment, mortgage delinquencies). This can partially be attributed to central bank purchases, and we can also point to the avoidance of worst-case outcomes for the remainder of the improvement. Delinquency data for non-mortgage receivables (credit cards, auto) are much better than expected, and we will continue to monitor these areas to understand the health of the consumer and the ability to emerge from this downturn.
- Despite a deluge of corporate supply, corporate spreads narrowed in sympathy with equity outperformance. As official purchases of corporate ETFs have begun, we believe spreads can continue narrowing despite weakness in underlying economic data.
- We maintain an overweight position in MBS, a neutral position in corporates, and an underweight to Treasuries.
- Our highest conviction remains an overweight to mortgages – specifically lower coupon mortgage pools and mortgage derivatives off very seasoned collateral that is less sensitive to rate-induced prepayments.
Chief Investment Officer – Total Return
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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.
The Bloomberg Barclays US 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.”
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.
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.
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