SUMMER 2009
(Q2-2009 Data)
Volume 19, Number 3

he average taxable bond fund rallied 5.3% in the second quarter, the best performance since the second quarter of 1995. Newgate’s Global Fixed Income Portfolio gained 23.4% during the quarter and is up 28.2% year to date, compared to 7.8% and 6.1% for the Lipper Global Fixed Income and 1.8% and 1.9% for the Barclays Aggregate Bond indices, respectively.

Market Review. Credit markets have continued to heal, with most sectors recovering to their pre-Lehman collapse metrics. The massive liquidity pumped into the global credit system by most central banks has resulted in low LIBOR and other short term rates. The current steepness of the yield curve clearly reflects some measure of confidence that rates will be rising in the near future. Pessimists, however, point to fears of inflation and a possible collapse in the US dollar as reason for the rise in longer rates.

While there are pundits and players on both sides of the deflation/inflation argument, the market itself seems to be finding a middle ground consistent with economic recovery. US Treasuries declined during the quarter. There are fears of rising inflation and the massive issuance required to pay for fiscal stimulus, bailouts and Obama administration proposals on healthcare and energy. Credit sensitive instruments, including high yield bonds, traded loans and convertible bonds all rallied sharply.

The debate on the future of the US dollar (and therefore on US government bonds) as both a medium of exchange and a store of value now seems a permanent feature of the economic landscape. A number of foreign leaders, from the European Central Bank to various officials of the Chinese government, have suggested alternatives to the dollar. China has even engaged in currency swaps with Argentina, Malaysia and other countries to allow the use of the yuan in trade between their countries. This has weakened the dollar against most major currencies, and especially against commodity currencies such as the Australian dollar and the Brazilian real.

Portfolio Performance. Performance was positive across all sectors of the Portfolio. Discounts shrank for most funds, especially those holding government and higher grade corporate bonds. But returns for the Portfolio were also powered by rising NAVs as underlying fundamentals improved. Preferred stock funds and multi-strategy funds with large allocations to preferred stock were among the better performing. This sector is dominated by financial companies, which were buoyed by the successful “stress test” and repayment of TARP funds. Convertible bond funds also delivered strong results, as a rising equity market boosted their value. Funds with large allocations to US Treasury bonds and agency-backed mortgages had positive returns but did not keep pace with the more aggressive funds that are more credit-sensitive.

Portfolio Activity. The sharp rise in prices during the quarter pushed a number of funds to be fairly valued, while others still have value. Several high yield funds, including the Blackrock Corporate High Yield V Fund (HYV), began to trade at or near premiums and were sold. Overall, high yield bonds now comprise less than 10% of the Portfolio. Senior loan funds, such as the Eaton Vance Floating Rate Income Fund (EFT), were increased to 17% of the Portfolio. Since they have floating interest rates, senior loans will benefit if interest rates rise. They are also a senior claim in bankruptcy and historically have had higher recovery rates than traditional bonds. We also have built an 8% position in (predominantly high grade) mortgage securities.

Exchange Traded Funds (ETFs) are increasingly becoming a significant tool for management of the Portfolio. Given current fund valuations, these represent an attractive way to express our views on the US dollar, without taking the risk of widening discounts on closed-end funds. Currency ETFs now comprise just under 6% of the total Portfolio.

Outlook. The “rising tide” of the global economy and better expectations are not lifting all boats equally. While investment grade bonds and even some high yield bond funds seem fairly, if not overvalued, other aspects of the market, such as emerging market debt and senior loans are still discounted. After last quarter’s strong rally, we remain cautious on the markets. ETFs and senior loans allow for participation in the recovery but also contain defensive elements. The Portfolio’s 7.5% yield represents excellent value should the US Treasury market continue to sell off and force investors to rethink their core holdings.