Already, domestic fixed income markets have assumed multiple personalities this year, taking only three months to flip and then flip again.
After adjusting at the end of last year to the likelihood of the Federal Reserve tightening monetary policy, with U.S. Treasuries price declines outpacing those of corporate bonds, these two markets abruptly reversed directions. The U.S. Treasury market had steadily drifted lower prior to the FOMC December announcement, producing negative total rates of return for the broad sector in each of the final three months of 2015. Corporate bond prices had also been discounted during this period, but not by as much, with the negative total return for corporate bonds only half that of Treasuries. Given the assumption that Federal Reserve policy moves to raise interest rates are commonly associated with accelerating economic growth and a robust environment for corporate profitability, credit spreads commonly tighten during the initial phases of Fed tightening. However, as 2015 ended, investors around the world began the New Year with a dire new outlook.
As investors began to question the domestic implications of a global economic decline, market sentiment quickly deteriorated. As a result of such recalibrations, investors reconsidered how quickly the FOMC would pursue additional interest rate hikes – resulting in a swift reversal of expectations in the fixed income markets. U.S. Treasury prices rallied dramatically from the prior quarter’s sell-off, and corporate bond prices were unable to keep pace. As a result, the yield spreads which had narrowed steadily through the close of 2015 widened with a vengeance. In January, for example, U.S. 1-10 year Treasuries outperformed 1-10 year investment grade corporate bonds by over one hundred basis points, a full 1.06%. Similarly, high yield and emerging market fixed income securities fell dramatically from already depressed levels.
In this way, the difficulty of accurately predicting short-term market swings, or short-term interest rate fluctuations, was once again confirmed. With no time to accumulate any interest or coupon income, short-term fixed income performance measurements were dominated by price changes, and fixed income investors were stunned by the quick marked-to-market deterioration of portfolio values. Even the preferred securities market, which had been the fixed income champion sector for the past several years, fell appreciably – down 5.44% for the year by mid-February. Yet this reversal was only the beginning of the story.
To their collective credit, fixed income investors perceived the sell-off as an opportunity rather than a harbinger of haunting gloom. Just as quickly as prices had fallen, they recovered – and then some. With equal force to the January sell-off, intermediate corporate bond prices rallied and performance for the sector ended the first quarter ahead of intermediate U.S. Treasuries, earning a 2.82% total return, as measured by the BofA ML 1-10 Year U.S. Corporate Index. Investors viewed preferred securities, even more dramatically at discounted price levels, as attractive investments as well. The sector climbed back to produce respectable quarterly gains for the eighth time over the past nine quarters, as measured by the BofA ML Fixed Rate Preferred Stock Index. This marked the quarter’s second reversal.
In the Roosevelt Current Income Portfolio, we were able to take advantage of some of this market volatility by seizing the opportunity to increase our allocation to preferred securities and thus boost yield. Differing from shorter-term oriented strategies, this form of yield enhancement is more strategic in nature, and may increase annual incomes for extended time periods. In addition, extending the maturities of certain corporate bonds at wider yield spreads provided yield enhancement as well. Given our income-oriented focus, constantly seeking yield and maintaining duration (in other words, staying fully invested), are two fundamental tenets that underlie our active management decisions.
As evidenced by the abrupt swings in short-term market sentiment already experienced this year, we continue to anticipate that predicting interest rate changes is a fool’s errand. Rather, we believe a commitment to your goals and diligently maintaining your investment discipline often proves the greatest defense in periods of market volatility. Here at Roosevelt, we remain committed to the Current Income Portfolio’s key investment philosophy of maximizing income while preserving principal through a flexible, benchmark-agnostic approach.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.