First Quarter 2021 | Fixed Income Commentary

Published on April 16th, 2021

First Quarter 2021 | Fixed Income Commentary

Market Overview

The Current Income Portfolio (CIP) declined by -1.04% during the first quarter, with corporate bonds declining by -1.77% and preferred securities by -1.03. On a relative basis, CIP’s corporate bonds outperformed the intermediate corporate bond index return of -2.19% and CIP’s preferred securities outperformed the Wells Fargo Preferred Stock ETF (PSK) return of -1.38%.

U.S. Treasury yields increased throughout the first quarter, with the market-implied first interest rate hike by the Fed moved up to December 2022, rates climbing by over 60-80bp in each of the 5, 7 and 10-year U.S. Treasury note maturities, and the 2Y – 10Y segment of the curve growing steeper by almost 80 bps.

The sharp rise in yields drove longer duration securities to underperform to a greater degree, in both corporate bond and preferred securities markets, as their higher sensitivity to changes in interest rates effectively translated into greater losses from the move higher in rates. As a result, CIP’s corporate bonds outperformed the intermediate corporate bond market due to CIP’s slightly shorter duration. CIP’s preferred securities also slightly outperformed PSK due to CIP’s shorter duration as well as to its greater allocation to institutional fixed to floating rate preferred securities. CIP’s institutional $1,000-par preferred securities gained by about 0.94% in the first three months of the year, whereas CIP’s retail $25-par preferred securities declined by -1.55%. Institutional preferred securities, which all have fixed to floating rate coupons, held up better than retail fixed rate preferred securities due to the nature of their coupon structure, in that the floating rate component can sometimes benefit from expectations of higher interest rates. Credit spreads remained steady throughout the month, with CIP’s corporate bond credit spreads ending the quarter unchanged, relative to the prior quarter, and CIP’s preferred securities credit spreads widening slightly.

Looking forward, we expect that the impact of fiscal stimulus and vaccination progress should continue to boost economic growth and remain supportive of credit risk assets. Moreover, the Federal Reserve remains committed to highly accommodative monetary policy over the near term, with the ability to adjust the rate paid on excess reserves as well as the average maturity date of monthly asset purchases, should the need arise to make further adjustments. In addition, retail flows and demand for new issues in U.S. credit markets continue to be strong, despite the slightly negative total returns year-to-date, and yields in the U.S. also remain attractive to foreign investors on a hedge-adjusted basis.

While these factors are supportive of current valuations, CIP is positioned defensively with respect to the possibility of rising rates. Client accounts are currently funded with a shorter duration than the intermediate corporate bond market, and the duration of existing accounts edges even lower as time passes. In addition, by including fixed to floating rate coupons and limiting the fixed rate preferred securities coupon purchases to those with coupons at or above 5%, we believe CIP’s preferred securities allocation is positioned to perform opportunistically, in relative terms, than other fixed rate instruments if interest rates rise. In fact, with about one-third of the portfolio maturing in the next 1-3 years, we look forward to the opportunity to reinvest the proceeds into higher yielding securities in the future. We continue to seek to provide investors with high quality, risk adjusted, high current income without taking on excess credit or interest rate risk to do so.

As of March 31, 2021

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