MINC: 4th Quarter 2020 Portfolio Manager Review
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The U.S. presidential election, a trade deal between the UK and the EU, and announcements from the scientific community marked the final quarter of 2020 and signaled a significant moment in history as the world turned the tide on the COVID-19 pandemic that dominated the year. Scientific advancements are likely to continue as the fight against the virus wages on and the focus turns to the logistics of offering the available vaccines to the global population. The quarter also saw the return of some local and regional disruptions to economic activity as restrictions were reinstated to control the virus spread. The disruptions may weigh on near-term economic results, but we believe that the financial markets will remain focused on the progress of distributing the vaccines and the normalization of activity in 2021.
The unprecedented global monetary and fiscal policy response to combat the disruption of the pandemic was broad based and has proved successful in restoring economic activity. As the early initiatives have expired or reached limitations, central bankers have urged the politicians to continue to support the recovery with more fiscal assistance. After months of political wrangling, a year-end funding bill provided some much needed relief. We expect that the policymakers will continue to fine-tune their response to the crisis as warranted, and the incoming U.S. administration may make further adjustments in the coming months.
In our view, economic activity and corporate earnings will continue to rebound over the course of the new year. Financial markets pushed higher during the quarter, and we are continuing to find attractive investment opportunities across the many sectors of the bond market. We believe sector and issuer selection in this environment is critical and favors active over passive management. Elevated cash levels and a high degree of personal savings will be a tailwind to growth in the coming quarters.
Spread sectors outperformed U.S. Treasuries during the quarter led by higher beta sectors such as corporate high yield, bank loans, and emerging market (EM) debt. Within most sectors, lower quality and longer duration outperformed. Corporate credit outperformed most securitized sectors such as commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS), and asset-backed securities (ABS).
We continue to see value in spread sectors. While the pandemic certainly has proven disruptive to economies, we are confident that the crisis will be resolved with time. Our multi-sector approach to fixed income investing, time-tested over close to three decades, enables us to scan the bond market for the most attractive investment opportunities wherever they may be and is ideally suited for the current environment.
- Underweight U.S. Treasury and agency mortgage-backed securities and overweight spread sectors.
- Allocation to the corporate high yield sector. With the election behind us, hopes for another stimulus package, and positive COVID-19 vaccine news, optimism for an economic recovery drove risk assets substantially higher in the quarter with the lower-rated credit tiers leading the way. Within the corporate high yield sector, an active but manageable primary market and positive fund flows also helped push valuations higher.
- Allocation to the high yield bank loan sector. The sector benefited from the same factors noted above. For bank loans specifically, the technical picture remains supportive as a combination of CLO issuance and manageable redemptions from retail funds provided sufficient demand for new issuance net of repayments during the quarter.
- Albeit small, allocation to, and issue selection within, the EM debt high yield sub-sector. With the risk-on sentiment, the EM high yield sector was the best performing sector by a wide margin.
- Issue selection and the higher quality positioning within high yield bank loans and corporate high yield. While allocations to these sectors were beneficial, issue selection within both was a detractor relative to performance versus the respective indices. Consistent with the overall risk-on backdrop experienced for most of the quarter, lower quality within both sectors outperformed.
- The funds underweight to the corporate high quality sector versus the Bloomberg Barclays aggregate Index had a negative impact on the fund’s performance during the quarter, however issue selection and positioning within the sector was beneficial.
Sector Changes: We reduced exposure to U.S Treasuries, asset backed securities, and Yankee high quality. We increased exposure to corporate high yield, commercial mortgage-backed securities, and corporate high quality.
Non-U.S. Exposure: Over the quarter the overall non-U.S. exposure within the Fund remained relatively unchanged. We are using this volatile and uncertain time in the markets to look for names we believe are undervalued yet can sustain the current macro backdrop. We continue to favor sovereigns in larger capital structures, remain overweight high grade over high yield, and prefer hard currency over local market exposure.
Corporate High Quality: Spreads within the investment grade corporate sector moved steadily lower throughout the fourth quarter to end the year at 96 bps, just three bps wider for the year and 30 bps through long-term averages. Net supply was slightly negative in the quarter, though 50% ahead of the prior record for the full year. Issuers have large cash and debt balances and we expect relatively light supply in 2021. While valuations are becoming constrained broadly, we still see attractive opportunities within the BBB segment of the market, often in the more COVID-19-sensitive industries.
Corporate High Yield: The sector rallied hard in the quarter following vaccine announcements. Unlike earlier in the year, fourth quarter performance was led by risky CCC credits and those industries most impacted by the virus. The strong market performance led to wide open capital markets. While total issuance was down from the very high levels of Q2 and Q3, the issuers tapping the market were of much lower quality than prior quarters. Total issuance for the quarter was still high relative to past years and the full-year issuance set a new record at $418 billion. After the rally into year end, one has to question how much performance was pulled forward into 2020. Yields are at all-time lows and spread levels are below average – both may limit potential total returns in 2021. During the quarter we made net additions to high yield in the Fund. The vaccine news led to some fundamental changes in our views on certain sectors and names.
Securitized Product: Our allocation to the securitized product sectors (non-agency RMBS, ABS, and CMBS) continued to be accretive to the overall performance of the portfolio. Credit spreads continued tightening in the fourth quarter but not with the same vigor as in the third quarter. We maintained a meaningful allocation to the space to continue to reap the advantage of liquidity and risk-adjusted spreads offered by our securitized investments. The new issue market still offered investors a concession with respect to pricing and more robust deal protections as rating agencies maintain a conservative approach to underwriting given uncertain economic results due to COVID-19. The fundamental performance of the U.S. consumer continued to improve as delinquencies and forbearance numbers trended lower, which positively impacted the valuation of our securities. The positive news on the vaccine front comforted investors and, in turn, spreads on lower-rated securities rallied. We finished the quarter with many securitized product valuation levels surpassing pre-COVID-19 levels.
|Security Description||Portfolio Weight %|
|US TREASURY N/B 0.125 5/31/2022||3.35%|
|JP MORGAN USD GOVT MONEY MARKET INSTL||3.17%|
|US TREASURY N/B 0.375 9/30/2027||1.33%|
|BX 2018-GW B FRN 5/15/2035||1.27%|
|MORGAN STANLEY FRN 10/24/2023||0.84%|
|JPMORGAN CHASE & CO FRN 11/1/2169||0.80%|
|NRZT 2016-3A A1 FRN 9/25/2056||0.72%|
|GCAT 2019-NQM1 A1 STEP-CPN 2/25/2059||0.71%|
|WLAKE 2018-3A C 3.61 10/16/2023||0.71%|
|FORD MOTOR CREDIT CO LLC 3.2 1/15/2021||0.67%|
As of 12.31.2020.
As always, we believe it is important to stay diversified, have granular positions, and emphasize liquid investments. COVID-19, like other events that trigger volatility in the market, can affect valuations and create opportunities that we can take advantage of in the course of implementing our multi-sector relative value approach. We highlight the importance of credit selection and positioning in the current environment. Given the widening in spreads late in the first quarter of 2020, valuations had cheapened substantially and we continue to identify opportunities in spread sectors, including those within non-investment grade sectors that we have added to and may continue to add to in the Fund. Even with the recovery since the end of March, valuations look attractive in many spread sectors and we believe some of the best total return and yield opportunities in fixed income can be found in spread sectors. Some of the specific sectors where we are finding the best relative value opportunities are out-of-index/off-the-run ABS, non-agency RMBS, high yield bank loans, corporate high yield, EM high yield, and BBB rated corporate investment grade.