During the first quarter of 2021, FISR returned -4.07% at NAV.1 The fund finished the quarter with overweights to long-term corporate bonds, high-yield bonds and cash.
Fixed income sector positioning was disadvantageous. Positive contributions from targeted allocations to mortgage-backed securities (MBS), cash and intermediate-term credit bonds were offset by undesirable impacts from exposure to bonds on the long end of the curve. Our outlook for credit was positive, driven in part by our models, which forecasted a steeper yield curve, implying positive future economic conditions and tighter credit spreads. Allocations to intermediate investment grade credit and high yield aided returns as the asset classes outperformed the Bloomberg Barclays US Aggregate Bond Index. However, the anticipation of massive fiscal stimulus and improving economic growth fueled inflation fears, causing yields to rise. This had an outsized negative effect on longer-dated bonds, both investment grade credit and Treasuries, which yield greater sensitivity to rising rates. These exposures dented returns. Elsewhere, an allocation to mortgage-backed securities that was held throughout the quarter, buoyed performance as they finished down, but outperformed the Bloomberg Barclays US Aggregate Bond Index. The asset class was supported by slightly higher coupons, a lower duration and support from the Federal Reserve (Fed).
Portfolio Positioning and Outlook If there is (or was) a bubble in fixed income, the last few months of market action have already done a relatively decent job of deflating it. And while the sudden increase in government borrowing costs can feel unnerving, these types of interest rate scares were not especially uncommon in the decade following the global financial crisis. Using the US 10-Year Treasury as a barometer, we’ve had four instances where interest rates have jumped by more than 100 basis points in relatively short order. Thus far, none of these episodes have durably altered the longer term trend of persistently lower rates of interest.
In late 2010, increased quantitative easing from the Fed bolstered inflation expectations just as firming economic data lifted real yields. But the bump in interest rates was short-lived as Greek debt concerns would soon send investors rushing toward high quality sovereigns, notwithstanding an errant interest rate hike from the European Central Bank. The taper tantrum in the spring of 2013 sent shockwaves through all manner of interest-rate sensitive assets, but interest rates would again grind lower through all of 2014 despite the start of Fed tapering. The rise in rates that accompanied President Trump’s election victory in 2016 was more enduring, but also petered out eventually amid weakening economic data, the US-China trade war and central bank policy easing.
Is the current sell-off in rates markets different, or in several months will we again be moving inexorably toward the zero barrier in US government bond markets (and back to more deeply negative rates in continental Europe)? At the moment we continue to see some additional upward pressure for interest rates in most developed markets. Our views are influenced by improving economic data and also take into account possible over-reactions to prevailing and upcoming inflation prints. Risks of inflation appear to be more tangible than they have been for quite some time, at least from an intermediate horizon or secular perspective. But markets are signaling only a transitory bump as can be seen by the breakeven inflation rate priced into 2-year TIPS as compared with longer-term inflation expectations embedded in 10-year TIPS. And there is the reflexive risk that, should interest rates start to move too far too fast, the Fed could easily step in with interventions akin to the 2011 Operation Twist which was quite successful in calming long-term interest rates.
Our positive outlook for credit is driven in part by our models, which forecasted a steeper yield curve, implying positive future economic conditions and tighter credit spreads. Further, despite relatively tight spreads (much like valuations for most assets), the credit environment still looked attractive against a better economic backdrop.
Source: FactSet, as of March 31, 2021. Past performance is not a reliable indicator of future performance.
1 Source: ssga.com, as of March 31, 2021.
Bloomberg Barclays US Aggregate Bond Index A benchmark of the performance of the US dollar denominated investment grade bond market, which includes investment grade government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the US.
Mortgage-Backed Securities (MBS) Pooled securities that are backed by mortgage loans. Agency mortgage backed securities refer to securities backed by pools of mortgages issued by US government-sponsored enterprises such as Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC).
Overweight The weighting of a given security, industry or market sector that exceeds the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
TIPS or Treasury Inflation Protected Securities Treasury securities that are indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are backed by the US government and are thus considered an extremely low-risk investment. The par value of TIPS rises with inflation, as measured by the Consumer Price Index, while the interest rate remains fixed.
Underweight The weighting of a given security, industry or market sector that is less than the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
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