Unless otherwise noted, all figures and opinions are as of March 16, 2020 and are preliminary and subject to change.
Commentary1
- Valuations generally were not compelling at the beginning of the year. BBB and high-yield corporate spreads were near multi-year lows:
Source for both charts: The Federal Reserve Bank of St. Louis. Both Charts cover the period 1/1/2015 through 3/16/2020. OAS (Option Adjusted Spread) is a measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. The effective yield is the yield of a bond which has its coupons reinvested after payment has been received by the bondholder. Effective yield is the total yield an investor receives in relation to the nominal yield or coupon of a bond.
- As such, FPA New Income (“FPNIX”) had just 6.6% of its net assets invested in credit-sensitive (defined as all bonds rated BBB+ or lower) and FPA Flexible Fixed Income (“FPFIX”) had just 9.6% as of December 31, 2019.
- This compares to 26.7% in credit-sensitive for the average FPNIX peer in the Morningstar Short-Term Bond Category and ~50% for the average FPFIX peer in the Morningstar Nontraditional Bond Category.2
Recent events:
- Given the dramatic decline in interest rates, we have been actively reducing the duration of both Funds. The reduced duration is a result of our internal stress tests of each Fund’s holdings and of each portfolio to see their ability to withstand a 100 bps rise in interest rates over a twelve-month period without losing money, which is in line with our goal to seek to preserve capital.
- We have marginally added to credit in both Funds. We believe that high-yield bond and loan valuations are much cheaper than they were at the start of the year but, overall, are not cheap on a risk/reward basis yet once you exclude energy-related companies. As shown in the chart above, BBB and high-yield option adjusted spreads (which include energy bonds) are at 2016 levels. This is despite the fact that energy prices and the economy are likely to be worse than in 2016.
- Absolute yields are not quite yet at their highs in 2016 given the decline in interest rates and as absolute value investors, our philosophy is that absolute yields must compensate us for the risk of absolute losses.
| FPNIX | 12/31/2019 | 3/16/2020 |
| Exposure to “credit-sensitive” | 6.6% | 7.1% |
| FPFIX | 12/31/2019 | 3/16/2020 |
| Exposure to “credit-sensitive” | 9.6% | 11.4% |
- Year-to-date, we have been able to find what we believe to be attractive AAA and AA rated opportunities despite lower Treasury yields. As an example, we have purchased AAA and AA rated bonds recently that yield 100 bps more than the comparable maturity Treasury.3
- We expect continued volatility in credit given valuations and liquidity. We are ready to take advantage of opportunities once they meet our risk/reward parameters.
- We believe both funds have sufficient liquidity available in both cash & equivalents and highly liquid investment grade securities (rated AA & above) to take advantage of potential future opportunities. In addition:
- Neither fund has seen material outflows
- Both funds have durations of less than 2 years at the portfolio level, helping to reduce the need for high levels of liquidity (all else equal) because monthly amortization of structured product investments should increase cash availability
Respectfully yours,
Thomas H. Atteberry Abhijeet Patwardhan
Portfolio Manager Portfolio Manager
- All Fund data is preliminary as of 3/16/2020. Portfolio composition will change due to ongoing management of the Funds.
- Source: Morningstar Direct.
- Past results are no guarantee of future results. There is no guarantee that we will be able to continue to find such opportunities in the future.
Important Disclosures
This update is for informational and discussion purposes only and does not constitute, and should not be construed as, an offer or solicitation for the purchase or sale of any securities, products or services discussed, and neither does it provide investment advice. Any such offer or solicitation shall only be made pursuant to the Fund’s Prospectus, which supersedes the information contained herein in its entirety.
The views expressed herein and any forward-looking statements are as of the date of the publication and are those of the portfolio management team. Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. This information and data has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.
