MINC: 4th Quarter 2021 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/minc.

Market Review

COVID variants – including the latest strain, Omicron – continue to complicate the response from healthcare systems and policymakers seeking to contain the pandemic. Though some countries have imposed tighter restrictions in response to Omicron, early studies suggest the strain may be less severe than earlier variants.

The economy has mostly recovered from the events of 2020 as financial markets grew accustomed to living with the virus, though distortions remain. Employment metrics continue to improve, corporate profits hit a new record for the year, and by many measures the U.S. consumer is in better shape today than pre-pandemic. We expect elevated cash levels and a high degree of personal savings to be a tailwind to growth in the coming quarters.

Meanwhile, the persistence of inflation caused by problems with supply chains, labor shortages and pandemic-induced changes in consumer behavior led the administration’s stimulative economic agenda to be put on hold over inflation concerns. With midterm elections on the horizon and narrow congressional majorities in place, it remains to be seen if elements of the stimulus can still move forward in 2022. We still believe that elevated inflation readings will likely fade over the course of 2022 as developments in technology, globalization, and consumption trends returning to normal levels help keep prices contained.

In response to higher inflation and a strengthening economy, the Federal Reserve (Fed) has adjusted the pace of the taper. As of November, it had already begun winding down its asset purchases of $120 billion of UST/MBS per month and is now aiming to finish the taper by March 2022 rather than its prior mid-year target. Assuming no more adjustments, interest rate increases are expected to follow in the second quarter. The pace, timing and magnitude of “lift-off” remains uncertain, but financial markets are pricing in three interest rate increases in 2022 and three more in 2023. In addition to interest rate increases, the market’s attention will turn to the Fed’s management of its $8.8 trillion dollar balance sheet.

Spread sector returns were mixed relative to U.S. Treasuries due to modest volatility in the fixed income markets during the quarter. Higher beta, less interest rate sensitive sectors such as high yield bank loans and corporate high yield securities generally outperformed. U.S. Treasury rates increased both on the front end and in the belly of the curve while it decreased on the long end. The 5-year Treasury yield increased 29 basis points, the 10-year Treasury yield was 2 basis points higher, and the 30-year Treasury yield was 14 basis points lower.

As the market digests the Fed’s pivot on inflation, we continue to believe active sector and issuer selection is critical to take advantage of market volatility as it arises. Our approach to fixed income – the approach we’ve implemented for close to three decades – enables us to scan the bond market for the most attractive investment opportunities and is ideally suited for the current environment.

Portfolio Review

Positive Contributors:
•   High Yield Bank Loans
Allocation to the high yield bank loan sector had a positive impact on performance during the fourth quarter. The sector benefited from a continued strong macroeconomic recovery, improving fundamentals, positive technical environment, and a constructive backdrop for risk assets. The technical environment remains healthy, supported by an increase in inflation, a more aggressive stance on rates from the Federal Reserve, and subsequent demand for floating rate assets to protect against rising rates. Loan demand from both retail and institutional investors has remained strong with December marking the thirteenth straight month of retail inflows and record CLO issuance in 2021.

•   Corporate High Yield
Allocation to the corporate high yield sector contributed positively during the quarter. Although the sector was volatile during the quarter, it outperformed most other fixed income sectors due to a drop-off in supply later in the quarter, strong corporate earnings, a very low default rate, and resilience in the global economy. Overall, fundamentals within the sector continue to improve and valuations are reflective of that.

•   Asset backed Securities
Issue selection within the ABS sector contributed positively during the quarter. The U.S. consumer continues to perform extremely well as the ability to service its debts remains strong, driven by a strong labor market, stimulus programs, low rates, and access to credit.

Performance Detractors:
Positioning within Bank loans — Higher quality positioning within the bank loan sector was a slight detractor relative to the sector index.

Current Fund Strategy and Positioning

  • Reduced exposure to non-agency residential mortgage backed, asset backed and corporate high quality securities.
  • Increased exposure to United States Treasuries and bank loans
  • In addition to changes to the Fund’s sector allocation during the quarter we continue to look for the best relative value within sectors, which includes optimizing positions within sectors.
  • EM debt and non-U.S. exposure: While the fund’s EM exposure is a small percentage of the Fund’s total assets, it ticked slightly higher throughout the quarter. Amidst increasing volatility in the global backdrop due to central bank policy aimed at combatting inflation, we continued our bias of preferring large cap structures with more liquidity. On the margin we were able to use brief moves of spread widening to add to names whose fundamentals were compelling and whose valuations were affected by the macro backdrop with modest spread widening. We continue to prefer hard currency debt over local market instruments but continue to look for specific entry points in a handful of countries where real rates are becoming more attractive.
  • Investment grade (IG) corporates: Spreads broke out of a tight trading range in the fourth quarter as the market digested the Omicron variant, inflation, and the Fed hiking forecast. Ending the year at 92 basis points, spreads remain tight to the five-year average (+115), but well off the mid-year lows (+80). The technical environment was favorable – net supply was manageable while flows were consistently positive through early December when modest outflows were reported. With long end rates moving lower, the asset class has avoided ugly total returns, which we feared given its long duration. Fundamentals are also encouraging – net leverage has declined relative to pre-COVID levels and should improve further once fourth quarter earnings are reported. Third quarter revenues and earnings rose 19% and 40% respectively as margins held in better than expected given the supply chain concerns for large firms. The consensus forecast expects 20% earnings growth in the fourth quarter and 9% growth in 2022. We don’t expect much increase in debt in 2022, which will improve credit metrics further. Our exposure to the asset class is at a five-year low, which positions us to take advantage of some of the recent spread weakness. However, valuations remain tight on a historical basis. We favor the BBB segment of the market.
  • Corporate High Yield: The high yield market was volatile during the fourth quarter. While the total return was positive, there were bouts of both positive and negative total returns throughout the three-month period. The volatility was driven by several factors including third quarter earnings impacted by rising input costs and supply chain disruption, uncertainty around Fed Chairman Jerome Powell’s renomination and subsequent policy pivot, and the Omicron variant. The quarter started off strong as the index spread tightened 20 basis points to a low of +274 but would later gap out to +337 as fears of the Omicron variant surfaced late November. As more data emerged regarding Omicron and its potential impact, spreads settled in and tightened into the +300 range. Quality slightly outperformed during the month. Technicals were mixed as we saw outflows for the quarter but a slower primary market (2021 set a record for total supply at north of $460 billion). We remain favorable on the asset class but will keep a watchful eye on the impact of Omicron and the Fed’s reaction. Activity during the quarter was light, but we kept our bias of increasing overall credit quality in the fund. Industry-wise we were active the cable/telecom space, which remains volatile as cable faces competition from wireline players and the satellite industry sees numerous new constellations being launched.
  • Securitized: We continue to focus on the U.S. consumer and the housing sector, maintaining a significant overweight on asset-backed securities and non-agency residential mortgage-backed securities. This is supported by strong fundamentals in both sectors: this past quarter, unemployment continued to trend lower (4.2%), and job openings remain high. Consumer confidence has trended lower, though driven by virus fears rather than a cooling labor market. The U.S. consumer’s debt service is also near its lowest point in history, while the savings rate remains historically high. On the housing side, we continue to see the tailwinds of low mortgage rates and limited supply. Housing also benefits from demand driven by the pandemic. Unlike agency MBS, non-agency RMBS offers direct exposure to real estate and mortgage credit. We continue to overweight both.

Top Holdings

Security Description Portfolio Weight %
US TREASURY N/B 1.75 6/15/2022 2.13%
US TREASURY N/B 1 12/15/2024 1.50%
US TREASURY N/B 0.125 3/31/2023 1.00%
EART 2021-1A C 0.74 1/15/2026 0.91%
BANK OF AMERICA CORP 1.734 7/22/2027 0.77%
CMLTI 2019-RP1 A1 FRN 1/25/2066 0.76%
BX 2018-GW B FRN 5/15/2035 0.71%
XROAD 2021-A A2 0.82 3/20/2024 0.71%
EART 2019-2A E 4.68 5/15/2026 0.70%
PRPM 2021-RPL1 A1 FRN 7/25/2051 0.70%

As of 12.31.2021. Cash not included.

Outlook

Our multi-sector relative value approach enables us to take advantage of opportunities when events that trigger volatility, such as inflation worries or the Omicron variant, affect valuations. In the current environment, we believe some of the best total return and yield opportunities can be found in spread sectors, where credit selection and positioning is key. Specific sectors that demonstrate the best relative value for us include:

  • Out-of-index/off-the-run asset-backed securities
  • Non-agency residential mortgage-backed securities
  • High yield bank loans
  • Corporate high yield
  • BBB-rated investment grade corporates

The Fund maintains its higher quality focus and short duration to limit both spread and interest rate volatility. As always, we aim to stay diversified, maintain granular positions, and emphasize liquid investments.

Respectfully, Newfleet Asset Management AdvisorShares Newfleet Multi-Sector Income ETF (MINC) Portfolio Manager  

Past Manager Commentary

Definitions:

10-Year Treasury Note is a debt obligation issued by the United States government that matures in 10 years. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity. An advantage of investing in 10-year Treasury notes, and other federal government securities, is that the interest payments are exempt from state and local income tax. However, they are still taxable at the federal level.

An Asset Backed Security is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt.

basis point is one hundredth of a percentage point (0.01%).

The Bloomberg Barclays Capital Aggregate Bond Index measures the performance of the U.S. investment grade bond market. One cannot invest directly in an index.

Commercial Mortgage Backed Security is a type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS can provide liquidity to real estate investors and to commercial lenders. As with other types of MBS, the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years.

Correlation is a statistical measure of how two securities move in relation to each other.

Coupon is the interest rate stated on a bond when it’s issued. The coupon is typically paid semi-annually.

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices.

Fundamentals are the qualitative and quantitative information that contributes to the economic well-being and the subsequent financial valuation of a company, security or currency. Analysts and investors analyze these fundamentals to develop an estimate as to whether the underlying asset is considered a worthwhile investment.

Investment Grade is a rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such as Standard & Poor’s, use different designations consisting of upper- and lower-case letters ‘A’ and ‘B’ to identify a bond’s credit quality rating. For example, ‘AAA’ and ‘AA’ (high credit quality) and ‘A’ and ‘BBB’ (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations (‘BB’, ‘B’, ‘CCC’, etc.) are considered low credit quality (speculative), and are commonly referred to as “junk bonds.”

Residential Mortgage-Backed Security is a type of mortgage-backed debt obligation whose cash flows come from residential debt, such as mortgages, home-equity loans and subprime mortgages. A residential mortgage-backed security is comprised of a pool of mortgage loans created by banks and other financial institutions. The cash flows from each of the pooled mortgages is packaged by a special purpose entity into classes and tranches, which then issues securities and can be purchased by investors.

Spread is the difference between the bid and the ask price of a security or asset.

Spread sectors include all non-Treasury investment grade sectors including federal agency securities, corporate bonds, asset-backed securities, mortgage-backed securities and commercial mortgage-backed securities.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security.

Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.


Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting www.advisorshares.com. Please read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.

There is no guarantee that the Fund will achieve its investment objective. An investment in the Fund is subject to risk, including the possible loss of principal amount invested. The Fund’s investment in fixed income securities will change in value in response to interest rate changes and other factors, such as the perception of the issuer’s creditworthiness. Fixed income securities with longer maturities are subject to greater price shifts as a result of interest rate changes than fixed income securities with shorter maturities. The Fund’s investments in high-yield securities or “junk bonds” are subject to a greater risk of loss of income and principal than higher grade debt securities. Emerging and foreign market investments can be more volatile than U.S. securities and will expose the Fund to adverse changes in foreign economic, political, regulatory and currency exchange rates. See prospectus for details regarding specific risks.

Shares are bought and sold at market price (closing price) not NAV and are not individually redeemed from the Fund. Market price returns are based on the midpoint of the bid/ask spread at 4:00 pm Eastern Time (when NAV is normally determined), and do not represent the return you would receive if you traded at other times. 

Holdings and allocations are subject to risks and change.

The views in this commentary are those of the portfolio manager and many not reflect his views on the date this material is distributed or any time thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.