FALL 2011
(Q3-2011 Data)
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.