SUMMER 2010
(Q2-2010 Data)
Volume 20, Number 3

ven as the global economic recovery slows, investors have poured new money into the fixed income markets. Newgate’s Global Fixed Income Portfolio gained 1.6% during the quarter and is up 8.4% year to date, compared to 0.4% and 2.1% for the Lipper Global Fixed Income and -0.04% and -0.3% for the Barclays Capital Global Aggregate Bond Indices, respectively.

Market Review. The bond market remains buoyant despite low interest rates. Though the global economy is improving, data releases in May and June suggest a tepid, rather than the desirable “V-shaped” recovery that is more common post-recession. Interest rate increases by the Federal Reserve and other major central banks have been put off for the foreseeable future. Emerging markets are generally accelerating much faster than their developed market counterparts, with many emerging countries raising interest rates.

The market’s increasing pessimism on the economy can be seen in both the flattening of the Treasury yield curve and wider spreads for corporate bonds. While spreads on A-rated bonds barely moved, spreads for B-rated bonds widened 100-200 basis points, depending on maturity. Even government agency yields rose relative to Treasuries past three year durations.

The US dollar index (DXY) rose 9% from March 31, 2010 to mid-June as fears of sovereign debt default spread from Greece to Spain and Portugal. The developed world is seen as vulnerable to credit issues, though the “debt stress” is most acute in the smaller Euro-zone countries. Many economists believe it is only a matter of time before larger nations face a funding issue. The UK is already considered highly leveraged, due in large part to the government’s takeover of failing banks and mortgage companies.

Portfolio Activity. Our more neutral view on the dollar relative to other developed market currencies led us to reintroduce non-dollar investments in the Portfolio. We purchased shares of the Templeton Global Income fund (GIM) to gain exposure to both developed and emerging market bonds. We reduced exposure to TIPS though the sale of the Barclays TIPS iShare (TIP), though we maintained positions in two closed-end funds from Western Asset/Claymore that are trading at modest discounts.

US Government related assets (Treasuries, mortgages and preferred stocks) comprise approximately 50% of the Portfolio. Global investors show nearly unlimited willingness to hold Treasuries. While conceptually these securities offer little value at current rates, concerns about deflation and fear of defaults by weaker sovereign issuers have kept the market trending higher. Both mortgage and preferred securities (primarily issued by financial firms) benefit from direct and indirect support by the Federal Reserve. Even though the Fed no longer actively purchases mortgage securities, it has not divested either. Despite low yields on US government bonds, there are still value opportunities in funds like the Alliance Bernstein Income Fund (ACG), with a yield near 6% and a discount over 6%, for a fund primarily invested in Treasury and agency bonds.

Our exposure to the corporate sector remains focused on investment grade bonds, with a heavy emphasis on essential service companies in the utility sector. The Duff & Phelps Utility and Corporate Bond Trust (DUC), with a 6.8% yield, typifies the income advantage by moving beyond Treasuries. In contrast, we reduced holdings in the high yield and convertible bond sectors. While the income potential is greater in those areas, they have a higher correlation with equities and greater overall risk, both unwarranted given the economic uncertainty.

Outlook. The long awaited shift out of Treasuries has been postponed, and in some ways reversed, as the global economy struggles to recover. The Portfolio was reallocated accordingly and successfully. The increased number and specificity of new ETFs has positively impacted our ability to manage the Portfolio, allowing us to add to opportunistic themes and to be more defensive at times, with increased liquidity. There are still substantial risks in the fixed income markets, but we believe that the expanded toolbox and our relative value orientation will allow us to be successful.