Volume 21, Number 4
e have changed the name of the Portfolio
from Global Fixed Income to Total
Return Income (TRI). Total Return
Income better reflects how we have been
managing the Portfolio since 1988. The Portfolio has
always had a broad mandate, including all manner of
income-producing securities regardless of geography.
Performance will be reported relative to the widely used
Barclays Capital(formerly Lehman) US Aggregate Bond
Index. The previous index, the Lipper Global Income
Fund Index based only on closed-end funds, has become
less relevant given the broad issuance of ETFs and other
investment tools. Most clients use the Barclays Aggregate
as the benchmark for their fixed income portfolios.
Given our typical role as a total return component within
a diversified fixed income portfolio, we believe it is appropriate
to report our performance against this index.
Portfolio Review. Newgate’s Total Return
Income Portfolio declined 9.3% in the third quarter and
is down 3.8% year to date, compared to gains of 3.8%
and 6.7%, respectively, for the Barclays Capital US Aggregate
Bond Index. Much of the recent underperformance
of the Portfolio is due to a widening of fund discounts.
US Treasury bonds and Treasury-focused funds
had the best performance during the quarter. Yields on
the 10 and 30 year bonds fell below 2% and 3%, respectively.
These are levels just above lows set at the depth
of the credit crisis in 2008. The Federal Reserve’s newly
announced policy, dubbed Operation Twist, further adds
to the decline in longer dated bond yields. The policy
would be better named Operation Flatten, since that is
its effect on the yield curve. Its impact on the actual
economy is much less certain.
Mortgage-related funds had mixed performance.
Those that invest primarily in government sponsored
entities were slightly positive for the quarter. Funds
that invest directly in mortgages (rather than mortgage
pools) had sharp declines. Investment grade bonds, and
the funds that invest in them, were up for the quarter.
Anthing with lower credit quality declined. Preferred
shares were particularly hit hard, since any increased
probability of a credit crisis impacts banks – the main
issuer of preferred shares. Overall, the market remains
highly risk averse.
The flight from Europe and the return to the US
dollar resulted in losses for most non-US bond funds.
Traders fled the Euro, which fell 8.5% against the dollar.
Emerging market debt funds performed the worst.
Emerging market central banks have been on a different
cycle. Brazil and Turkey surprised the market by recently
cutting interest rates to boost their economies and
weaken their currencies. Newgate has had a positive view
on the dollar all year. For all the issues with the US dollar,
most other currencies are worse.
Portfolio Activity. We increased the allocation
to senior loan funds from under 5% to nearly 20%
last quarter. We are not in an ideal market for loans, as
interest rates are expected to stay low for the foreseeable
future. However, the senior loan index fell 6% in a
six week period early in the quarter and loan funds fell
even more as discounts widened. As a result, funds such
as Invesco Van Kampen Senior Income Trust (VVR)
with a 6.8% yield are an attractive method of diversifying
the Portfolio with little interest rate risk. The sale of the
Morgan Stanley Emerging Markets Debt Fund (MSD)
eliminated investments in non-US debt, though we still
have some foreign exposure through multistrategy funds.
Outlook. Fear of a renewed credit crisis sparked
by European government defaults is a major factor in
recent market activity. We are not in a credit crisis and
believe that European policy makers have the ability to
avert one. What is needed are steps demonstrating that
macroeconomic issues are being addressed in a sober
manner. Until this happens, capital markets will be subject
to a high degree of volatility.
The ongoing global financial turmoil has turned
what historically are the safest instruments, US Treasury
bonds, into risky ones. With the 10 year Treasury near
2%, investors are almost certain to have a negative real
return on their investment. Newgate’s Total Return
Income Portfolio has a 7.7% yield and the potential for
capital appreciation. Both will be required to earn a real
return in this low interest rate environment.