Published on Jul. 22, 2019
Second Quarter 2019 Fixed Income Commentary
Fixed income markets in the U.S. posted a second consecutive quarter of gains to close out the first half of 2019 with positive performance. During the second quarter the ICE BofA U.S. 1-10 YR Intermediate Corporate Index was up 3.13%. The ICE BofA U.S. 1-10 YR Treasury and Agency Index and the ICE BofA U.S. Fixed Rate Preferred Securities Index were up 2.30% and 3.02%, respectively for the quarter.
April kicked off the quarter with relatively sanguine market conditions, as concerns over U. S. and China trade tensions and an economic slowdown remained subdued as the S&P hit new all-time highs. Moreover, Fed Chairman Powell in early May said that the Fed remained less concerned with downside risks from a slowdown in global economic activity and more confident in meeting their near-term inflation targets. This was supported by March retail sales and light auto vehicle sales data which came in better than expectations.
During the month of May, however, U.S. trade tensions heated up; this time not only with China but with Mexico as well. Uncertainties regarding a global manufacturing slowdown induced recessionary fears which we believe drove equity markets down and investment grade spreads wider. Almost immediately upon seeing the weaker economic data, the Fed reacted and hinted its intent to support the US economy as it has done for many years. The “Fed Put”, the need to provide accommodative policy, was once again pulled out of the Fed’s toolbox and markets rallied in relief.
The larger global issue that is likely to keep U.S. rates low is the fact that an increasing percentage of global bonds have negative yields. What this means is that if an investor buys a Swiss bond or a German bond for example, if they expect to hold it until maturity, they will lock in certain capital losses. This global dearth of bonds with real positive yield will in our opinion, lead to continued demand for U.S. dollar-denominated fixed income assets, despite the fact that the U.S. deficit is expanding. It boils down to the simple argument that the U.S. is the best house in an increasingly bad yield neighborhood. This is not a new issue in international fixed income markets but it is getting to the point where global consultants and major international pension funds are being forced to reconsider their local bond allocations and are increasingly looking for alternatives away from home.
Roosevelt’s CIP portfolio is designed to protect capital while delivering more attractive yield than cash. Importantly, we remain committed to our capital preservation objective in a manner designed to maintain liquidity and relatively attractive yields in an environment where yield is becoming increasingly rare.
The duration of the portfolio has been structured to be intermediate in nature, and we seek to enhance the yield of the overall portfolio through the addition of investments in companies that have issued preferred securities with attractive yields. We maintain that this market segment remains a beneficial portfolio diversifier for income-oriented investors to own in addition to bonds. In addition, aggregate portfolio yield characteristics may be improved over time through adjusting the preferred security allocation and by alternating the mix of security structures within the investor’s portfolio mix.
After starting 2019 with a lighter than usual preferred security allocation, during the quarter we took advantage of depressed market prices and raised our allocation to, for us, a more traditional 25%. At the same time, the distribution of preferred security structures in the CIP portfolio steadily increased to about 50% invested in fixed-to-float structures. We believe these types of securities work well in our style because they add to the portfolio’s overall yield characteristic, but do not add to interest rate risks beyond a traditional intermediate-term bond portfolio.