Total Return Perspectives: July 2021
Longer term Treasury yields fell for a fourth consecutive month in July, as concerns around the resurgence of coronavirus weighed on forecasts for continued economic growth. Agency MBS underperformed investment grade corporates and Treasuries. While some inflation metrics set generational highs, and other economic data indicated a continued recovery, investors were focused on the potential impact of viral spread.
Review:
- The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) returned +1.12% in July, the fourth consecutive positive monthly return. The Bloomberg Barclays U.S. Corporate Index (+1.37%) led the major investment grade sectors as duration boosted returns. Treasuries (+1.36%) also continued their positive streak as the yield curve continued to flatten. Mortgage-backed securities (MBS) lagged (+0.63%) largely due to their shorter duration profile and fears that prepayments will remain elevated due to lower mortgage rates.
- July headline CPI increased to 5.4% (with core CPI +4.5%) year-over-year, which is well above the Fed’s targeted level of 2.0%. As pointed out last month, investors will continue to study data for clarity on whether inflation will subside as temporary factors such as supply chain disruptions resolve or if pricing pressures broaden out with inflation being more persistent.
- While Treasury yields fell across the maturity spectrum, the yield curve continued to flatten. The 2-year yield fell 6 basis points to 0.19%, the 5-year yield dropped 17 basis points to 0.70%, the 10-year yield fell 21 basis points to 1.23%, and the 30-year yield fell 17 basis points to 1.89%.
- The option-adjusted spread of the Corporate Index widened 6 basis points in July to 86 basis points. Despite posting a slightly better return than Treasuries overall, the corporate sector underperformed duration-matched Treasuries by 37 basis points.
- The Bloomberg Barclays U.S. MBS Index underperformed duration-matched Treasuries by 19 basis points as spreads for the sector widened 4 basis points in July. The decline in Treasury yields – depressing mortgage rates – has prepayment fears top of mind among mortgage investors.
- The fund (-0.33%) underperformed the BC Agg (+1.12%) in July. The underperformance is mostly attributable to a reduced duration profile and somewhat to an underweight in Treasuries.
Standardized performance can be viewed here: Monthly and Quarter End Performance
Outlook:
- Treasury yields are incongruent with current measures and future forecasts of inflation. While our defensive posture in rates has hampered performance in recent months, we see no material reason to embrace low yields at these levels. We continue to reduce our long corporate exposure, and we are awaiting better entry points to add MBS. We have been active in TIPS, buying dips in breakeven spreads and selling when these recover – we expect volatility in TIPS to continue.
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 3/31/21) is 0.70%
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 (IG 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.
Treasury inflation-protected securities (TIPS) are a type of Treasury security issued by the U.S. government that are indexed to inflation in order to protect investors from a decline in purchasing power.
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-20210804-0305]
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