FALL 2009
(Q3-2009 Data)
Volume 19, Number 4

losed-end fixed income funds continued to outpace the general bond markets with another strong quarter of performance. Every sector across the closed-end fixed income fund universe had positive returns. Newgate’s Global Fixed Income Portfolio gained 14.2% during the quarter and is up 46.3% year to date, compared to 9.0% and 15.6% for the Lipper Global Fixed Income and 3.7% and 5.7% for the Barclays Aggregate Bond Indices, respectively.

Market Review. Credit markets rallied as the global central bank driven re-liquification continued unabated. Despite some public hand wringing by various officials and private sector economists, policy makers have made it clear that they will err by “too loose,” rather than “too tight,” monetary policy. While overall economic statistics have been mixed, measures of credit market healing, if not quite health, are apparent. The arcane statistics of credit and OIS spreads, LIBOR rates and similar measures have moved closer to normal levels, and in some cases have even moved to pre-Lehman collapse levels.

Debate on the role of the US dollar in the global economy has dominated the headlines. Emerging markets, especially China, had their vociferous calls for an expanded role in reshaping the global economy answered at the September G20 summit. The ten largest emerging markets collectively now have record levels of foreign currency reserves. While Chinese reserves have been well documented, both Brazil and Russia have been increasing their reserves following last year’s collapse. These reserves have strengthened currencies across the globe.

This return to near normality has come on the back of massive central bank intervention. Two questions are raised: 1) When do central banks begin to withdraw this liquidity? and 2) What will the role of the US dollar be in this “new normal” environment?

There are no easy answers, but there are at least a few reasonable conclusions:

1) The value of US Treasury and similar assets is likely to decline quite sharply as rates increase.

2) Investments linked to credit are likely to outperform.

3) Non-dollar assets are also likely to outperform, but will be highly volatile and best traded on a tactical, rather than strategic basis.

4) Inflation will become a motivating force for investors, even if government statistics show muted increases.

Portfolio Activity. The allocation to floating rate senior loans is now over 20% and likely to increase even further. These assets actually increase in value as rates rise, unlike Treasuries which decline with rising rates. Funds like the Eaton Vance Floating Rate Income Trust (EFT) offer great value, with a 6.5% current yield at an 8% discount from NAV. This fund will actually benefit from higher interest rates. Conversely, our allocation to Treasury and agency securities is now less than 2%. Although we believe that the trend for the US dollar is decidedly negative, there will still be periods of dollar strength. We reduced our allocation to non dollar assets to 15% after a significant move during the quarter. Emerging markets debt had been particularly strong; the Templeton Emerging Markets Income Fund gained more than 40% in less than six months.

We increased our allocations to preferred shares and mortgages during the quarter. Both bank preferred shares (accounting for most of the market) and mortgages have been significant beneficiaries of the current loose monetary policy. Several programs announced, but not yet enacted, such as the Public Private Investment Program (PPIP) should provide additional support to both of these markets. Unleveraged ETFs are a cost effective way to access the mortgage market without taking on the additional risk of leverage.

Portfolio Performance. Performance was positive across all sectors of the Portfolio. As the financial markets strengthened during the quarter, net asset values climbed and discounts narrowed. In addition, most funds in the Portfolio have benefited from rising dividends.

Outlook. We are at an inflection point in the financial markets. Growth is coming back, albeit with heavy support from global monetary authorities. Just as with a child learning to ride a bike, the markets must eventually be able to stay upright once this support is removed. At Newgate, we believe this will be the case and investors should be preparing for the next battle − rising rates and higher inflation. The Portfolio’s 6.2% yield, low duration and significant cash position, give us flexibility to move as the financial markets shift.