WINTER 2012
(Q4-2011 Data)
Volume 22, Number 1

ewgate’s Total Return Income Portfolio gained 4.0% in the fourth quarter, compared to a 1.1% gain for the Barclays Aggregate Bond Index. Continued intervention in the credit markets by central banks has resulted in artificially low government bond yields. Newgate’s Portfolio focuses primarily on worldwide opportunities across all income oriented investments that can have higher yields than government or agency debt.

Market Review. The fixed income markets remind us of an episode of Seinfeld. Everyone talks and talks, but not much actually happens. The European powers have engaged in over two dozen summits since the debt crisis began. While the market has reacted, at times violently, to every syllable uttered pre, post and during these summits, the net accomplishment has been hard to measure. There has been little in the way of policy change anywhere. The US Treasury yield curve looked nearly identical at the beginning and end of the quarter, with further inaction promised by the Fed for the foreseeable future. There have been intermittent signs of improvement in the global economy, most notably in the US employment market. However, fear of what may happen in Europe has resulted in poor bond auctions in Greece and Italy and a lack of lending in the interbank market.

The combination of low interest rates and marginal improvement in the global economy led to strong performance for credit focused funds. High yield bond funds were the best performers, followed by loan funds. Returns declined proportionately as credit quality increased. The strong performance of senior loans is interesting. These securities provide protection in a rising interest rate environment and often fall in value when the forecast for future interest rates declines. Their recent rise may suggest some hedging by investors who believe that rates will rise faster than expectations, or merely that these assets are very inexpensive given the improving economy. Treasury Inflation Protected Securities (TIPS) funds were strong performers, gaining over 2% while most conventional Treasury funds were up less than 50 basis points. However, TIPS purchases announced by the Fed may have had a disproportionate impact on that notoriously thinly traded market.

The US dollar rose against most currencies, reestablishing its role as the primary safe haven in volatile markets. We have been relatively bullish on the dollar throughout the year. Despite the very real problems in the US economy, the dollar remains the best of a bad lot among the major currencies and economies. Only the market for US dollars globally is large enough to absorb the liquidity as money is withdrawn from European banks.

Portfolio Activity. Even though the Portfolio had a strong return for the quarter, average fund discounts in the Portfolio increased, suggesting that fund valuations are better than they were at the end of September. During the quarter, the Portfolio’s already modest allocations to fixed rate government and corporate debt were reduced with the sale of the Duff & Phelps Utility and Corporate Bond Trust. Mortgage and real estate related investments were reduced slightly, but still comprise almost 25% of the Portfolio. The Fed has purchased $1.25 trillion in mortgage securities since the financial crisis and has said it will continue to reinvest in the sector as current loans get repaid. Expecting ongoing support from the Fed, we own funds like the Neuberger Berman Real Estate Securities Income Fund (NRO) with a 6.4% yield and at a 14.8% discount.

Outlook. We believe that the long term impact of the sovereign debt crisis will be as much psychological as economic. Securities once considered bedrock are now considered quicksand. However, the converse is also true. Corporate, mortgage and other securities have been reevaluated – the perception of their risk has declined relative to government bonds. Investors are looking to corporate securities (both bonds and loans) not only to enhance return but also as protection against interest rates that will eventually rise. The Newgate Total Return Income Portfolio, with a 7.6% yield and 10.7% discount, offers an opportunity for real return in this low growth, low interest rate environment.