SPDR® SSGA Ultra Short Term Bond ETF (ULST) – Q1 2021 Commentary
During the first quarter of 2021, ULST outperformed the Bloomberg Barclays US Treasury Bellwethers 3 Month Index on both a NAV and market price basis.
Performance During the first quarter, ULST outperformed its benchmark largely due to its overweight allocation to investment grade corporate credit and 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 accelerated distribution of 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 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. Bloomberg Barclays US ABS Floating Rate Index spreads tightened by 6 bps during the quarter, while the 1-3 year WAL component of the Index, where ULST tends to focus, tightened by 3 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 14 bps and 9 bps versus AAA and AA FRNs, respectively.1
Quarter in Review US economic activity continued to improve during the quarter as the large third wave of COVID-19 infections receded and COVID-19 vaccinations increased significantly. In conjunction with this improvement in economic activity, continued government support for the economy and the financial markets, including the passage of the $1.9 trillion American Rescue Plan Act, led to 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 6 bps, and the Bloomberg Barclays US High Yield Index spread tightened by 50 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. 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, US Agency MBS, and US Agency CMBS bonds (the Fed announced during the quarter that their purchase of US Agency CMBS would expire at the end of the quarter).2
Despite the continued improvement in economic data, the market is currently pricing in no Fed Funds rate hikes out to December 2022, a sign that the market understands the dovish ramifications of the Fed’s more flexible monetary policy framework, established August 2020.
Source: Bloomberg Finance L.P., January 1, 2020 – January 1, 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.
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 – 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 the US’s structural trend growth prospects.
First, on the heels of the American Rescue Plan Act, the White House announced plans to introduce major US infrastructure legislation, entitled The American Jobs Plan, which is estimated at $2.2 trillion. In addition, the discovery and rapid distribution of multiple COVID-19 vaccines may 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 boost productivity and turn the tide for 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 recovery.
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 at 28%, which is in the context of our long-term structural exposure for this strategy. The strategy has a 1.3% allocation to BB-rated credit (of which more than half is allocated to Ford, all of which is expected to mature in less than one year, and the remaining 0.6% is allocated equally to CIT Group Inc. and Centene Corp).
Asset allocation shifts included a 5% reduction in Financial Institutions, a 5% reduction in asset-backed securities (ABS), a 3% increase in Utility, and an 8% increase in cash. Within the context of a complex COVID-19 environment, which includes the rapid 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 2 bps at the end of the quarter, may produce positive excess returns for 2021.
Commercial Mortgage-Backed Securities
Source: State Street Global Advisors, as of March 31, 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.
AAA Rated or Above
Source: State Street Global Advisors, as of March 31, 2021. Ratings are based on the Bloomberg Barclays Composite Rating.
1 Barclays Live as of March 31, 2021 2 Bloomberg Finance as of March 31, 2021
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.
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The views expressed in this material are the views of James Palmieri through the period ended March 31, 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.
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