Treasury yields fell again in May and credit spreads approached recent tights as the virus continued to recede, allowing the reopening of the economy to progress. Economic data was noisy this month, largely due to base effects, but confirms the ongoing trend of renewed growth and signs of inflation.
Review:
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- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) posted a second consecutive positive month, rising 0.33%. The Corporate Index (+0.77%) led the other major investment grade sectors again, as spreads continued their march tighter. Treasuries (+0.34%) performed in line with the broader index as yields fell across the curve. Mortgage backed securities (MBS) were the clear laggard of the month (-0.18%) as rich valuations and talk of Fed tapering weighed on the sector.
- Economic data continued to reflect improvement. The headline non-farm payroll number fell well short of expectations (266k vs 1,000k) but when looking at the JOLTS index (8.123m vs 7.500m) the shortfall appears to be due to workers’ (un)willingness to return to work rather than the availability of jobs. CPI rose 0.8%, and the year-over-year number climbed to 4.2%. Producer prices rose 0.6% for the month, pushing the year-over-year number to an eye-popping 6.2%.
- The Treasury curve continued its modest rally from the previous month, led by the belly of the curve. The 2-year yield fell 2 basis points to 0.14%, the 5-year yield fell 6 basis points to 0.80%, the 10-year yield fell 4 basis points to 1.59%, and the 30-year yield fell 1 basis point to 2.28%. The lone point on the curve which ended the month higher in yield was the 20-year, which rose 2 basis points higher to 2.20% as the market struggled to digest supply from the auction.
- The MBS Index underperformed duration-matched Treasuries by 36 basis points. Mortgage spreads struggled to keep up with the performance of Corporates and Treasuries as we began the month at historically rich valuations. The sector also had to contend with several Fed governors publicly discussing the possibility of tapering the current quantitative easing program. While we think this is not a risk in the near term, when the Fed begins to taper, they will likely reduce their MBS purchases first.
- The fund (+0.25%) marginally underperformed the BC Agg (+0.33%) in May. The underperformance is primarily attributable to a reduced duration profile, underweight to Treasuries, and overweight to securitized assets.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- While mortgage spreads cheapened a bit from their tightest levels in over 8 years, we have not yet added back to our reduced exposure in the sector. We remain constructive on ABS, non-agency MBS, and corporates. We are cognizant of their tight valuations as well, but we believe these continue to offer a combination of carry and modest potential for appreciation due to spread tightening as the economy reopens.
- Looking past the near term, we expect economic data to continue strengthening and inflation measures to remain elevated. The current scale of monetary and fiscal stimulus has rarely been undertaken concurrently. We are concerned the combination may create an inflationary environment that becomes more than transitory, which would likely result in elevated interest rate volatility that would necessitate an ongoing defensive duration exposure.
The Fund was rated 4 Stars against 270 funds Overall, 4 Stars against 270 funds over 3 Years in the Nontraditional Bond category based on total returns as of 3/31/21.
The Morningstar Rating™ for funds, or “star rating,” is calculated for mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period has the greatest impact because it is included in all three rating periods.
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Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.
Performance data quoted represent past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be higher or lower than the performance quoted. Performance data current to the most recent month end may be obtained by calling shareholder services toll free at (866) 236-0050.
The fund’s Gross Expense Ratio (as of 3/31/20) is 0.67%
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 U.S. 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.” The Osterweis Total Return Fund may invest in fixed income securities which are subject to credit, default, extension, interest rate and prepayment risks. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in foreign and emerging market securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used. Investments in preferred securities have an inverse relationship with changes in the prevailing interest rate. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in municipal securities which are subject to the risk of default.
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.
Spread is the difference in yield between a risk-free asset such as a U.S. Treasury bond and another security with the same maturity but of lesser quality.
Option-Adjusted Spread is a spread calculation for securities with embedded options and takes into account that expected cash flows will fluctuate as interest rates change.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
The producer price index (PPI) is a group of indices that calculates and represents the average movement in selling prices from domestic production over time.
The Job Openings and Labor Turnover Survey (JOLTS) program produces data on job openings, hires, and separations.
It is not possible to invest in an index.
All investments involve risk. Principal loss is possible. Treasury notes are guaranteed by the U.S. government and thus they are considered to be safer than other asset classes.
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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20210604-0233]
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