MENV: 1st Quarter 2022 Portfolio Review
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click www.advisorshares.com/etfs/menv.
AdvisorShares North Square McKee ESG Core Bond ETF (symbol: MENV) returned -5.57% in the first quarter of 2022, outperforming Bloomberg Aggregate index by 36 basis points. Market interest rates rose precipitously as expectations for the Federal Funds rate at the end of this year tripled from approximately 80 basis points at the beginning of the quarter to 2.40% on March 31st.
Driven by a continued rise in inflation, the rapid escalation of market interest rates and volatility were clearly the most prominent factors impacting performance in the first three months of the year. Hawkish commentary from the Federal Reserve contributed to a significant flattening of the yield curve. Market losses accelerated in March as war in Ukraine fueled further commodity price inflation.
The MOVE index, a measure of market volatility and indicative of the change in callable agency spreads, returned to levels not seen since the onset of COVID in early 2020. Corporate yield spreads, on the other hand, widened 24 basis points or less than 10% of the peak to trough range over the past two years.
Despite callable bond spreads widening out significantly at the end of the quarter, the best performing securities in the portfolio were found in the agency sector. With the agency universe experiencing a full cycle of volatility in just three months, spreads on callable bonds first tightened 25-40 basis points into reduced supply and lower volatility in January through mid-February. However, with the peak in market uncertainty and a heavy supply calendar in March, these same securities widened again by 40 to 100 basis points. Our portfolio was able to outperform in this environment due to tactical trading; we sold as spreads tightened in early February and subsequently bought back (and increased positions) at much higher spreads throughout March. CDs and the shortest maturity securitized holdings also performed well, adding yield with little downward price movement.
The corporate and mortgage sectors were a drag on performance, as yield spreads widened in response to the elevated inflation outlook and increasingly hawkish comments from the Fed.
|Security Description||Price $||Portfolio Weight %|
|US TREASURY N/B 1.875 4/30/2022||100.13||5.87%|
|WELLS FARGO & COMPANY 3.45 2/13/2023||101.16||3.08%|
|US TREASURY N/B 0.125 6/30/2022||99.89||3.03%|
|CRED SUIS GP FUN LTD 3.8 9/15/2022||101.05||2.89%|
|BANK OF AMERICA CORP 3.004 12/20/2023||100.32||2.73%|
|MORGAN STANLEY 4.875 11/1/2022||101.73||2.55%|
|US TREASURY N/B 0.125 3/31/2023||98.47||2.55%|
|AMERICAN EXPRESS CO FRN 5/20/2022||100.02||2.30%|
|ATHENE GLOBAL FUNDING FRN 1/7/2025||98.44||2.21%|
|JP MORGAN USD GOVT MONEY MARKET INSTL||1.00||2.20%|
As of 03.31.2022. Cash is excluded.
Excessive fiscal and monetary policy support, supply and labor shortages, and the onset of war in Ukraine combined to drive inflation well above expected and acceptable levels, spurring progressively more strident commentary from members of the FOMC. With short-term market interest rates now discounting a more aggressive central bank response, especially in the May and June meetings, we expect to see market volatility level off in the second quarter before receding in the summer months. Market interest rates should continue to move higher, though not at the breakneck speed witnessed in the first quarter. Financial conditions should continue to tighten, due to higher Treasury and mortgage rates, modestly wider credit spreads, and lower equity prices. This will slow the demand side of the economy while the supply side continues to cure. The Fed hopes to engineer a growth recession, maintaining modestly positive gains in economic output, while reining in inflation. From the current year-over-year reading of nearly 8%, consumer price inflation is expected to recede to 4.5% by yearend and 2.5% in 2023.
From a relative value standpoint, fixed rate callable and step-up coupon callable agencies remain our top choice in this environment, coupled with short maturity securitized assets. Agency holdings now represent 27% of portfolio market value, up from 18.5% at the beginning of the year. Short maturity securitized product is also attractive as wider spreads significantly increase the likelihood of outperforming equal duration Treasuries going forward. Finally, our quality bias in credit should continue to benefit performance as corporate earnings margins are pressured by the cost and availability of labor and other inputs.