MINC: 2nd Quarter 2022 Portfolio Review
Market Review
The Federal Reserve (Fed) and other major central banks shifted to a more hawkish tone in response to elevated inflation metrics. The Fed raised its main policy rate 125 basis points (bps) during the quarter and indicated its resolve to restore price stability while relying on economic data to form future policy action. The Fed has also begun to shrink its $8.9 trillion-dollar balance sheet in what we expect to be a largely passive exercise. As the European Central Bank is also poised to signal interest rate increases and its own balance sheet run-off, it will have to manage the complex task of preventing financial fragmentation among its member countries. The Bank of Japan remains a relative dove given local economic conditions, but it remains to be seen how much Yen weakness will be tolerated, given the policy divergences. Global central banking has a complicated task ahead.
Financial markets have priced in significant changes to the economic and earnings landscape during the quarter, as shown by total returns. The U.S. Treasury curve shifted higher: the 5-year Treasury yield jumped up 58 bps, the 10-year Treasury yield went up by 68 bps, and the 30-year Treasury yield moved 74 bps higher. Most spread sectors underperformed U.S. Treasuries with the shifting economic conditions.
Despite the quarter’s volatility, we see value being restored across most of the fixed income sectors in which we invest. It is our expectation that supply chains will heal over time and the Fed will be successful in returning inflation to acceptable levels. We continue to watch the economic data to inform our views on the possibility of recession. While our base case remains that any contraction would be mild, recession risks have risen.
As the markets digest global developments, 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 have 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
Asset-Backed Securities (ABS) — Allocation to the ABS sector had a positive impact on performance during the quarter. The sector benefited from demand for shorter duration assets and strength in the U.S. consumer. Securitized product continued to soften from a credit spread perspective, primarily driven by inflation and global macro concerns. Due to the fundamental backdrop, we remain positive on the U.S. consumer, though recent sentiment is showing signs of weakness. Inflation continues to chip away at purchasing power short term, but real wage growth is a positive, particularly for the lower quintile consumer.
High Yield Bank Loans Issue Selection — Issue selection and positioning within the high yield bank loan sector had a positive impact on performance. The higher quality focus of the bank loans in the Fund benefited performance as BB risk continued to outperform lower quality cohorts. Loans held in relatively well as shorter duration asset classes generally outperformed in the face of persistently high inflation, increasing hawkish rhetoric from the Fed, and rising U.S. Treasury yields. After 17 months of inflows, demand for the asset class turned negative, driven by elevated growth concerns. The net forward calendar remains manageable.
Non-agency residential mortgage-backed securities (RMBS) — The Fund’s allocation to the non-agency RMBS sector over agency mortgage-backed securities (MBS) had a positive impact on performance during the quarter. We continue to see the tailwinds of limited supply and judiciously offered mortgage credit, and unlike agency MBS, non-agency RMBS offers direct exposure to real estate and mortgage credit. However, record-setting housing values and sharply higher mortgage rates bring about future affordability questions.
Performance Detractors
Underweight to U.S Treasuries
Corporate High Yield Securities — Allocation to the corporate high yield sector had a negative impact on performance. Factors that have plagued the high yield market for the last few months persist: the war in Ukraine rages on, supply chain issues persist, and U.S. Treasury yields continued to rise as the market tries to handicap the levers the FOMC will pull to quell inflation. Fundamentals within the sector, while weakening, are holding strong as headwinds from supply chain issues, labor inflation and slowing growth persist, resulting in margin erosion. Despite another quarter of outflows, a muted primary market coupled with few fallen angels created a supply shortfall.
Current Fund Strategy and Positioning
- Reduced exposure to high yield bank loans and corporate high yield securities.
- Increased exposure to U.S. Treasuries, RMBS, and ABS.
- In addition to changes to the Fund’s sector allocation during the quarter, we continue to optimize positioning within sectors based on our view of the best relative value.
EM Debt and Non-U.S. Exposure: The Fund’s EM allocation remains at historical lows. Volatility in global markets, rising inflation in many EM countries, and tighter monetary policies support our minimal allocation. The Fed’s rate hikes further rattled jittery markets and raised fears about a recession in the near future. Spreads on the EMBI Global are 113 bps wider, with investment grade names 34 bps wider and HY names nearly 260 bps wider. We continue to maintain our preference for hard currency debt and have no local currency exposure in the Fund.
Investment Grade (IG) Corporates: Total returns were worse than -7% for the second consecutive quarter to open 2022, bringing total returns near -15% in one of the worst stretches on record for the market. Companies started to deploy excess cash in the second quarter to repurchase beaten-up shares, but fortunately this shareholder-friendly activity has been more prevalent for the highest ratings tiers, while riskier IG credits have been more conservative. Earnings estimates for 2022 have risen over this year and sit north of 10% currently, though there is considerable angst that estimates are too high, and we find such estimates often lag behind changes in the economy. We are currently overweight commodity sectors and financials as we believe they are best positioned for a higher-rate environment. We are positioned with an overweight to the BBB segment of the market and favor taking part in the new issue market as its concessions remain at extreme levels.
Corporate High Yield: High yield had a terrible quarter as a combination of widening spreads and higher Treasury yields drove the index return to -10%. While credit fundamentals have been improving, these metrics have likely peaked, with margins already showing deterioration in the first quarter. The technical picture remains negative as retail funds continue to see significant outflows ($33 billion year-to-date). However, this has been somewhat offset by supply as issuance remains muted with just $68 billion issued this year. During the quarter, we reduced both absolute exposure to and risk within high yield as we felt spreads were not compensating for recession risk, as recessionary periods generally see high yield spreads north of 800 basis points. Trades during the quarter trimmed risk to the consumer via reductions in cruise line and airline industries, to Europe via a packaging firm sale, and to an issuer with possible refinancing risk. Purchases were focused on high quality energy and metals firms where we still have a favorable outlook, despite an overall more negative macro view.
Securitized: All securitized sectors saw negative returns as the market reacted to the Fed’s monetary tightening. The upside going into the second half of 2022 is that we see yield opportunities that have not been seen in many years. We are still constructive on both short duration credit backed by the U.S. consumer, and mortgage credit. We feel the risk/reward of higher quality securitized products is attractive. Most securitized products we invest in are being scrutinized using the Great Financial Crisis as a measure, and our thesis continues to be driven by good fundamentals. Low unemployment (3.6%), strong consumer excess savings, and real wage growth – especially for the lower quintile borrower – are all signs that the U.S. consumer will stay timely with its debt service payments. On the mortgage side, delinquencies are at historical lows, with limited to no affordable products compared to the market in the last housing crisis. With mortgage rates much higher, we expect a significant drop in activity leading to less supply for the back half of the year. This technical should allow credit spreads to respond favorably as we end the year. As a result, our portfolios have an overweight to the sector.
Top Holdings
| Security Description | Portfolio Weight % |
| US TREASURY N/B 0.125 3/31/2023 | 2.63% |
| US TREASURY N/B 1 12/15/2024 | 1.68% |
| US TREASURY N/B 2.5 4/30/2024 | 1.66% |
| BX 2018-GW B FRN 5/15/2035 | 0.81% |
| EART 2019-2A E 4.68 5/15/2026 | 0.79% |
| CMLTI 2019-RP1 A1 FRN 1/25/2066 | 0.73% |
| TPMT 2018-6 A1A FRN 3/25/2058 | 0.72% |
| BANK OF AMERICA CORP 1.734 7/22/2027 | 0.67% |
| PRPM 2021-RPL1 A1 STEP-CPN 7/25/2051 | 0.66% |
| CSMC 2021-RPL3 A1 FRN 1/25/2060 | 0.63% |
As of 06.30.2022. Cash not included.
Outlook
- Out-of-index/off-the-run ABS
- Non-agency RMBS
- BBB-rated corporate investment grade
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.
Newfleet Asset Management
AdvisorShares Newfleet Multi-Sector Income ETF (MINC) Portfolio Manager
A 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.
A 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.
A 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.”
A 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.