Approach: Guidance
Duration
Long duration bias as we believe interest rates are near cycle peaks
Yield Curve
Favor short-intermediate maturities
Spreads
Modest overweight
Volatility
Elevated in the short run, but should gradually normalize
Asset Allocation
Favor agency mortgage-backed securities, select commercial mortgage-backed securities and front-end Investment grade corporate debt
Looking Back
During the past month, we heard from the Federal Reserve and the Treasury Department, with the net result for U.S. bonds being a strong rally, reversing losses from the substantial increase in interest rates endured during the month of October. The U.S. Treasury increased its planned sales of longer-term securities by slightly less than most market participants expected in its quarterly debt-issuance plan, helping spur a rally in bonds amid the possibility that a wave of larger supply will soon come to an end. The Federal Reserve refrained from further rate increases at its last meeting. For the year, the Federal Reserve kept its resolve in attacking inflation by continuing its tightening cycle, then held off on hiking further in three of the last four meetings. While we cannot dismiss the notion that there may be one or even two additional increases in the near future, the bond market seems to have settled on the idea that we are approaching the end of this hiking cycle.
Opportunities Looking Ahead
During our last quarterly update, we discussed the higher yields available to fixed income investors across the spectrum of asset classes, while also pointing out the historically cheap valuations of the agency mortgage-backed and CMBS markets relative to mostly fair valuations available elsewhere in fixed income markets. As seen in the chart below, spreads for both remain at or close to their 10-year widest levels, with little change for other bonds.
Figure 1: Current Valuations Relative to 10-Year Range
OAS (Option Adjusted Spreads) as of October 31, 2023. Source: ICE Data
Corporates - ICE BofA US Corporate Index; High Yield - ICE BofA US High Yield Index; Agency RMBS - ICE BofA US Mortgage Backed Securities Index; CMBS – ICE BofA US CMBS Index; Subordinated ABS - ICE BofA AA-BBB US Asset Backed Securities Index; Emerging Markets - ICE BofA US Emerging Markets External Debt Sovereign & Corporate Plus Index.
Please see disclosures at the end of this presentation for additional information and index descriptions.
As the FDIC sales begin to wind down, and with valuations in other asset classes at best fair, it is our expectation that the agency mortgage market will begin to attract value-seeking investors and outperform. The much-maligned commercial mortgage-backed securities market continues to trade at levels not seen in many years, with the entire sector feeling the pain, and more acutely in specific segments such as office. However, away from office, fundamentals remain sound and we continue to seek select opportunities across the spectrum of properties, notably in self-storage and data centers. In the office sector, we look for opportunities in select Class A properties, and those with diverse sources of income, not solely reliant on leasing to corporate clients.
Figure 2: MBS Offer Attractive Yields with Lower Credit Risk
Source: Bloomberg, MacKay Shields LLC
Lastly, investment grade corporates have delivered low positive returns thus far in 2023, despite headwinds from higher interest rates. As we believe interest rates are near cycle peaks, we favor owning short and intermediate maturities in light of an anticipated steepening of the yield curve as the economy slows. We consider strong corporate balance sheets and lower expected issuance in 2024 against a relatively flat yield curve today that offers insufficient compensation to extend maturities.
Below we look at the relative attractiveness of short, intermediate and long-dated corporate bonds bucketed by maturities. Figure 3 shows the yield of each along with the credit spread widening that would be needed to breakeven (i.e., to produce a 0% return) over a one-year period. For the shortest of corporates, those with maturities between 1-year and 3-years, credit spreads would need to widen by more than 348 basis points to result in a negative return over the next year. The corresponding required spread widening for longer maturity debt, that maturing in 10-years and longer, is just over 50 basis points; this for an additional 20 basis points in yield! We view the yield differential as inadequate compensation for the risk of owning much longer maturity debt, as a 50 basis point spread widening would be plausible even in a relatively mild recession.
Figure 3: Value in Front-End Corporates
Source: Bloomberg, MacKay Shields LLC
IMPORTANT DISCLOSURE
Availability of this document and products and services provided by MacKay Shields LLC may be limited by applicable laws and regulations in certain jurisdictions and this document is provided only for persons to whom this document and the products and services of MacKay Shields LLC may otherwise lawfully be issued or made available. None of the products and services provided by MacKay Shields LLC are offered to any person in any jurisdiction where such offering would be contrary to local law or regulation. This document is provided for information purposes only. It does not constitute investment or tax advice and should not be construed as an offer to buy securities. The contents of this document have not been reviewed by any regulatory authority in any jurisdiction.
This material contains the opinions of certain professionals at MacKay Shields but not necessarily those of MacKay Shields LLC. The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and opinions contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Any forward-looking statements speak only as of the date they are made and MacKay Shields assumes no duty and does not undertake to update forward-looking statements. No part of this document may be reproduced in any form, or referred to in any other publication, without express written permission of MacKay Shields LLC. ©2023, MacKay Shields LLC. All Rights Reserved.
Information included herein should not be considered predicative of future transactions or commitments made by MacKay Shields LLC nor as an indication of current or future profitability. There is no assurance investment objectives will be met.
Past performance is not indicative of future results.
RISKS OF INVESTING IN ASSET AND MORTGAGE-BACKED SECURITIES
One of the principal risks of mortgage-related and asset-backed securities is that the underlying debt may be prepaid ahead of schedule if interest rates fall, thereby reducing the value of an investment. If interest rates rise, there is less prepayment risk but defaults may increase, potentially causing losses. This is not a complete list of risks associated with the strategy. Consult your professional advisors for further guidance.
COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
source information
ICE DATA INDICES, LLC (“ICE DATA”), IS USED WITH PERMISSION. ICE® IS A REGISTERED TRADEMARK OF ICE DATA OR ITS AFFILIATES, AND BOFA® IS A REGISTERED TRADEMARK OF BANK OF AMERICA CORPORATION LICENSED BY BANK OF AMERICA CORPORATION AND ITS AFFILIATES ("BOFA") AND MAY NOT BE USED WITHOUT BOFA'S PRIOR WRITTEN APPROVAL. ICE DATA, ITS AFFILIATES AND THEIR RESPECTIVE THIRD PARTY SUPPLIERS DISCLAIM ANY AND ALL WARRANTIES AND REPRESENTATIONS, EXPRESS AND/OR IMPLIED, INCLUDING ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, INCLUDING THE INDICES, INDEX DATA AND ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM. NEITHER ICE DATA, ITS AFFILIATES NOR THEIR RESPECTIVE THIRD PARTY SUPPLIERS SHALL BE SUBJECT TO ANY DAMAGES OR LIABILITY WITH RESPECT TO THE ADEQUACY, ACCURACY, TIMELINESS OR COMPLETENESS OF THE INDICES OR THE INDEX DATA OR ANY COMPONENT THEREOF, AND THE INDICES AND INDEX DATA AND ALL COMPONENTS THEREOF ARE PROVIDED ON AN “AS IS” BASIS AND YOUR USE IS AT YOUR OWN RISK. ICE DATA, ITS AFFILIATES AND THEIR RESPECTIVE THIRD PARTY SUPPLIERS DO NOT SPONSOR, ENDORSE, OR RECOMMEND MACKAY SHIELDS LLC, OR ANY OF ITS PRODUCTS OR SERVICES.
“Bloomberg®”, “Bloomberg Indices®”, Bloomberg Fixed Income Indices, Bloomberg Equity Indices and all other Bloomberg indices referenced herein are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by MacKay Shields LLC (“MacKay Shields”). Bloomberg is not affiliated with MacKay Shields, and Bloomberg does not approve, endorse, review, or recommend MacKay Shields or any products, funds or services described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to MacKay Shields or any products, funds or services described herein.
The following indices may be referred to in this document:
Bloomberg U.S. Aggregate Bond Index
The Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. Must have at least one year to final maturity regardless of call features. Must have at least $300 million par amount outstanding. Must be rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratings agencies: Moody's, S&P, Fitch. Must be dollar-denominated and non-convertible.
ICE BofA U.S. Corporate Index
Tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market.
ICE BofA U.S. High Yield Index
ICE BofA U.S. High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market..
ICE BofA US Mortgage Backed Securities Index
ICE BofA US Mortgage Backed Securities Index tracks the performance of US dollar denominated fixed rate residential mortgage pass-through securities publicly issued by US agencies Fannie Mae, Freddie Mac and Ginnie Mae in the US domestic market. 30-year, 20-year and 15- year fixed rate mortgage pools are included in the Index provided they have at least one year remaining term to final maturity and a minimum amount outstanding of at least $5 billion per generic coupon and $250 million per production year within each generic coupon.
BofA US Fixed Rate CMBS Index
BofA US Fixed Rate CMBS Index tracks the performance of US dollar denominated investment grade fixed rate commercial mortgage backed securities publicly issued in the US domestic market.
ICE BofA AA-BBB US Asset Backed Securities Index
Represents the portion of the ICE BofA US Fixed Rate Asset Backed Securities Index composed solely of bonds that are rated AA-BBB.
ICE BofA High Yield Emerging Markets Corporate Plus Index
ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities rated BB1 or lower. ICE Bank of America High Yield Master II Index tracks the performance of US dollar denominated below investment grade rated corporate debt publically issued in the US domestic market. To qualify for inclusion in the index, securities must have a below investment grade rating (based on an average of Moody's, S&P, and Fitch) and an investment grade rated country of risk (based on an average of Moody's, S&P, and Fitch foreign currency long term sovereign debt ratings). Each security must have greater than 1 year of remaining maturity, a fixed coupon schedule, and a minimum amount outstanding of $100 million.
ICE BofA Emerging Markets External Sovereign Index
ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.
DEFINITIONs
Active Management: Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund’s portfolio. Active management strategies typically have higher fees than passive management.
Duration: Duration can measure how long it takes, in years, for an investor to be repaid a bond’s price by the bond’s total cash flows.
Spreads: The difference of gap that exists between two prices, rates, or yields.
Yield Curve: A line that plots yields of bonds having equal credit quality but different maturity dates.
NOTE TO UK AND EUROPEAN AUDIENCE
This document is intended only for the use of professional investors as defined in the Alternative Investment Fund Manager’s Directive and/or the UK Financial Conduct Authority’s Conduct of Business Sourcebook. To the extent this document has been issued in the United Kingdom, it has been issued by MacKay Shields UK LLP, 80 Coleman Street, London, UK EC2R 5BJ, which is authorised and regulated by the UK Financial Conduct Authority. To the extent this document has been issued in the EEA, it has been issued by MacKay Shields Europe Investment Management Limited, Hamilton House, 28 Fitzwilliam Place, Dublin 2 Ireland, which is authorised and regulated by the Central Bank of Ireland.
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