SPDR® SSGA Ultra Short Term Bond ETF (ULST) – Q4 2020 Commentary

Performance
During the fourth quarter, ULST outperformed its benchmark largely due to its overweight allocation to investment-grade credit and asset-backed securities (ABS), prime credit cards and autos. In addition, the fund’s allocation to BBB corporate credit contributed to outperformance as the credit curve flattened during the quarter.

The discovery of multiple COVID-19 vaccines, the passage of more fiscal stimulus and continued improvement in economic activity and employment caused credit spreads to tighten during the quarter. For example, Bloomberg Barclays US Floating Rate Notes Index (FRN) spreads tightened by 8 basis points (bps) during the quarter, producing positive price and carry excess returns versus the fund’s benchmark. Bloomberg Barclays US Asset-Backed Securities Floating Rate Note Index spreads tightened by 12 bps during the quarter, while the 1- to 3-year weighted average life component of the index, where ULST tends to focus, tightened by 6 bps, 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 20 bps and 18 bps versus AAA and AA FRNs, respectively.¹

Quarter in Review
US economic activity continued to improve during the quarter in the context of a very large spike in COVID-19 infections and the announcement of the discovery of multiple COVID-19 vaccines. In conjunction with this improvement in economic activity, continued government support for the economy and the financial markets led to further easing of financial conditions across the board. For example, during the quarter, the above-mentioned FRN Index spread tightened 8 bps, the Bloomberg Barclays US Credit Index spread tightened by 36 bps, and the Bloomberg Barclays US Corporate High Yield Index spread tightened by 157 bps.²

Similarly, the US stock market is trading at levels that exceed pre-COVID-crisis levels and VIX, a measure of implied volatility for the stock market, is at post-COVID crisis lows. In terms of Fed monetary policy, the Fed funds rate remains near the zero-lower-bound and the Fed’s balance sheet grew by nearly $300 billion during the quarter, with purchases made directly in the US Treasury, US Agency Mortgage-Backed Securities (MBS), US Agency Commercial MBS, and investment-grade US corporate credit markets.2 We acknowledge the expiration of the Fed’s Secondary Market Corporate Credit Facility (SMCCF) on December 31, 2020, but believe that, going forward, the SMCCF is a new tool that the Fed will have for future bouts of extreme market volatility.

Finally, it’s worth repeating that in August — after a review of their monetary policy framework — the Fed announced a more flexible framework regarding their dual mandate of maximum employment and stable inflation, which, in summary, increases the hurdle for future Fed rate hikes. The market is currently pricing in no Fed funds rate hikes through December 2022, a sign that the market expects that the economy will take an extended amount of time to recover from the effects of COVID-19.

Portfolio Positioning and Outlook
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 — suggests to us a US trend growth rate of less than 2.0%.

As a team, we continue to be on the lookout for positive catalysts to trend growth, such as public investment in the form of a large infrastructure bill, and private investment, which has been constrained over the past two calendar years. As mentioned above, the discovery of multiple COVID-19 vaccines is clearly a positive catalyst that should serve as a mitigant to the negative trend effects from the virus. In summary, until an investment boom occurs, our structural analysis suggests that interest rates will remain historically low.

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. We continue to see improvements in economic activity and the labor market, and expect both to continue in 2021. 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 at 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 recovery. As a result of all of these factors, our outlook is for above-trend growth in 2021.

Given the zero-lower-bound achieved in Fed funds, we are positioned at the lower end or our duration range of 3 months to 9 months. There was no material change in the fund’s duration target versus its benchmark quarter-over-quarter.

Regarding our asset allocation strategy, we’re maintaining a diversified exposure to corporate industrials and financials, and prime ABS credit cards and autos. Our credit allocation to BBB-rated credit is 29%, which is just above our long-term structural exposure for this strategy. The strategy has a 1.5% allocation to BB-rated credit: 1.2% is allocated to Ford, all of which is expected to mature in less than one year; the remaining 0.3% is allocated to CIT Group Inc.

Asset allocation shifts during the quarter were minimal. Within the context of a complex COVID-19 environment, which includes the distribution of COVID-19 vaccines, our view is that the combination of continued economic improvement and unprecedented government stimulus will continue to support credit spreads in the near-to-intermediate term. At current valuations, the significant incremental yield offered by the portfolio versus its benchmark, which had a yield of just 9 bps at the end of the quarter, may produce positive excess returns for 2021.

Assest Allocation

Source: State Street Global Advisors, as of December 31, 2020. 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.

Quality Breakdown

Source: State Street Global Advisors, as of December 31, 2020. Ratings are based on the Bloomberg Barclays Composite Rating.