During the second quarter of 2021, ULST outperformed the Bloomberg Barclays US Treasury Bellwethers 3 Month Index on both a NAV and market price basis.
During the second quarter, ULST outperformed its benchmark largely due to its over-weight allocation to investment grade corporate credit. In addition, the Fund’s allocation to BBB corporate credit contributed to outperformance as the credit curve flattened during the quarter. The broad distribution of COVID-19 vaccines, continued improvement in economic activity and employment, and continued easy US monetary policy caused credit spreads to tighten during the quarter. For example, Bloomberg Barclays Floating Rate Note Index (FRN) spreads tightened by 3 basis points (bps) during the quarter, producing positive price and carry excess returns versus the Fund’s benchmark. As mentioned, the credit curve flattened during the quarter with BBB FRN spreads tightening 9 bps and 6 bps versus AAA and AA FRNs, respectively.
During the quarter, the broad distribution of effective COVID-19 vaccines accelerated the reopening of the US economy. In conjunction with this improvement in economic activity, continued government support for the economy and the financial markets led to a further easing of financial conditions across the board. For example, during the quarter, the above-mentioned FRN Index spread tightened 3 bps, the Bloomberg Barclays US Credit Index spread tightened by 9 bps, and the Bloomberg Barclays US High Yield Index spread tightened by 42 bps. Similarly, the US stock market is trading at all-time highs and the VIX, a measure of implied volatility for the stock market, is at post-COVID crisis lows. This broad-based easing of financial conditions occurred within the context of greater than expected signs of inflation in the US economy, which, given the unique nature of a recovery from a pandemic, is expected to be transitory. In terms of Fed monetary policy, the Fed Funds Rate remains near the zero-lower-bound and the Fed’s balance sheet grew by roughly $300 billion during the quarter, with purchases made directly in US Treasury and US Agency MBS. As can be seen below, despite the continued improvement in economic data, the market is currently pricing in no Fed Funds rate hikes, a sign that the market understands the dovish ramifications of the Fed’s more flexible monetary policy framework.
Source: Bloomberg Finance L.P., January 31, 2020 – June 30, 2021. The above targets are estimates based on certain assumptions and analysis made by Bloomberg Finance L.P., There is no guarantee that the estimates will be achieved.
Our fundamental active fixed income investment process has three components: structural, cyclical, and tactical. Our analysis of structural economic growth trends, which includes demographic trends, the trend growth rate of the labor force, and the trend growth rate of productivity – and the potentially negative effects of COVID-19 on each of these factors – suggest to us a US trend growth rate of less than 2.0%. As a result, our structural analysis suggests that interest rates will remain historically low. But there are reasons for optimism regarding US structural trend growth prospects. First, on the heels of the American Rescue Plan Act, the White House has announced plans to introduce major US infrastructure legislation. In addition, the discovery and rapid distribution of multiple COVID-19 vaccines should limit the negative impact of COVID-19 on the above structural economic growth trends. Finally, there are signs that pent-up private sector investment may accelerate in the coming quarters. Taken together, these catalysts could improve US structural trend growth, which has been in secular decline, but we remain in the early innings for each of these factors. As such, our historically low interest rate outlook holds.
Our analysis of cyclical trends focuses on economic activity momentum as well as policies that can serve to either extend or contract the economic cycle. As mentioned above, we continue to see improvements in economic activity and the labor market, and expect both to continue to improve throughout 2021 and well into 2022. We also expect continued government support for the economy in the form of substantial fiscal and monetary stimulus. Housing continues to be a powerful engine for the economy’s recovery as mortgage rates remain near all-time lows. Private sector investment should improve in 2021, especially in the form of inventory restocking. Finally, as mentioned above, US government stimulus has created very easy financial conditions, which serves to support the economy’s expansion.
Given the zero-lower-bound achieved in Fed Funds, we are positioned below the Fund’s strategic duration risk target of 0.50. The Fund’s duration declined from 0.40 to 0.29, quarter-over-quarter. Regarding our asset allocation strategy below, we’re maintaining a diversified exposure to corporate industrials and financials, prime ABS credit cards and autos, and CMBS. Our credit allocation to BBB-rated credit is at 27%, which is in the context of our long-term strategic exposure for this strategy. The strategy has a 2.0% allocation to BB-rated credit (which is an allocation used primarily for the optimal management of fallen angels). Asset allocation shifts included a 5% reduction in Industrials, a 4% reduction in ABS, a 5% increase in CMBS, and an 3% increase in Treasuries. Within the complicated context of a much improved COVID-19 environment and a Fed that is in the planning stages of tapering QE, our view is that the combination of continued economic improvement and the careful unwind of monetary policy stimulus will continue to support credit spreads in the near-term. At current valuations, the significant incremental yield offered by the portfolio versus its benchmark, which had a yield of just 4 bps at the end of the quarter, should produce positive excess returns for 2021.
|Security Type||Fund (%)||Index (%)|
|Commercial Mortgage-Backed Securities (CMBS)||7.9||0.0|
Source: State Street Global Advisors, as of June 30, 2021. Asset allocation is a method of diversification that positions assets among major investment categories. Asset allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.
|Credit Rating||Fund (%)||Index (%)|
|AAA Rated or Above||34.6||100.0|
Source: State Street Global Advisors, as of June 30, 2021. Ratings are based on the Bloomberg Barclays Composite Rating.
Basis Point (bps)
A unit of measure for interest rates, investment performance, pricing of investment services and other percentages in finance. One basis point is equal to one-hundredth of 1 percent, or 0.01%.
Bloomberg Barclays US Corporate High Yield Index
An unmanaged index that is comprised of issues that meet the following criteria: at least $150 million par value outstanding, maximum credit rating of Ba1 (including defaulted issues) and at least one year to maturity.
Bloomberg Barclays US Credit Index
An index that measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets.
Bloomberg Barclays US Dollar Floating Rate Note Index
An index that measures the performance of floating rate bonds issued by the US Treasury.
Bloomberg Barclays US Treasury Bellwether 3-Month Index
An unmanaged index representing the on-the-run (most recently auctioned) US Treasury bill with 3 months’ maturity.
Investing involves risk including the risk of loss of principal.
The views expressed in this material are the views of James Palmieri through the period ended June 30, 2021 and are subject to change based on market and other conditions. 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.
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
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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