SPRING 2010
(Q1-2010 Data)
Volume 20, Number 2

he global economic recovery and accommodative monetary policy continue to buoy the bond market. Newgate’s Global Fixed Income Portfolio gained 6.8% during the quarter and is up 67.2% for the past five quarters, compared to 1.7% and 20.0% for the Lipper Global Fixed Income and 1.8% and 7.7% for the Barclays Aggregate Bond Indices, respectively.

Market Review. “Is this a recovery, or just the next phase of the crisis?” That is the implicit question running through the global markets. Near zero interest rates, quantitative easing (central bank purchases of its own government’s bonds, a fancy way of saying“printing money”) and fiscal stimulus appear to have put the global economy on the right path. But is the economy strong enough to survive the withdrawal of government stimulus? Will commercial real estate, or some similar force, the proverbial “other shoe,” drop and renew the fear cycle? Or are we now set for a hyperinflationary environment due to excess liquidity? No one knows for certain, but the truth usually lies between the extremes.

What we do know is that fear drove money into government bonds, especially US Treasuries. Now with bond yields low, and the need for real return, and confidence increasing, long dated Treasury securities seem like the worst of a series of uncertain options. Monetary policy is tightening across emerging markets, and it is a matter of when, not if, developed world central banks will have to begin raising rates. Already the Federal Reserve has discontinued some of its “extraordinary measures” such as purchasing mortgage securities. The markets thrived following these changes, representing a positive sign of underlying confidence, but at the same time suggesting that rate increases may come sooner than originally expected.

The Dollar Index (DXY) rose 4.1% during the quarter and is up over 9% since its bottom in late November 2009. Despite the very severe issues facing the US, the other developed market economies are facing problems as bad if not worse. The prospect of a bailout for Greece is of great interest, not only for its direct impact, but for the precedent being set for other highly indebted countries. These include Portugal and Spain, but also the UK and Japan. Even the United States’ AAA status is no longer assured.

Portfolio Activity. The strength of the US dollar caused us to significantly reduce non-dollar exposure in the Portfolio. We eliminated long standing holdings such as Aberdeen Asia Pacific Fund (FAX), not long ago one of the larger holdings. We also sold the Morgan Stanley Emerging Market Debt Fund (EDD). While our long term view is that emerging market debt plays a valuable diversification role in a portfolio, we are finding better risk-adjusted opportunities elsewhere.

Preferred stocks are particularly attractive. The steep yield curve has improved the earnings picture for banks (which issue most of the preferred shares). Furthermore, since the Lehman failure, the Fed seems unlikely to let any major bank collapse. These two factors, plus high yields and attractive discounts, have led to preferred shares now comprising 17% of the Portfolio. Funds in the sector include the Blackrock Preferred Opportunity Trust (BPP) and the John Hancock Preferred Income Fund 2 (HPF), both yielding 8.2%, and trading at 9.0% and 5.2% discounts, respectively.

Ironically, we eliminated senior loan funds during the quarter. These funds are often stalwarts in the Portfolio when interest rates begin to rise. However, the S&P LSTA Leveraged Loan Index (a good proxy for the market) is up over 50% from its December 2008 bottom and rose 4.7% in the first quarter of 2010. The closed-end funds in this sector are now trading at premiums. So even though thematically we like this sector of the fixed income market, we have eliminated exposure based on valuations.

Outlook. At Newgate, we believe that money is just beginning to move out of Treasuries and into other segments of the fixed income market. There is still substantial value despite the recent gains in the Portfolio. We believe the keys to success will be to stay short duration and to invest without preconceived ideas of what should work. Instead, we are taking a nimble approach to a market full of both risk and opportunity and expect to continue to be rewarded for it.