MINC: Q3 2019 Portfolio Manager Review
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The primary drivers of fixed income market performance remain largely unchanged from recent quarters. Geopolitical developments (e.g., trade, Mideast tensions, and European politics), recession fears, and central bank headlines all continue to be significant market movers. We continue to monitor market fundamentals, technicals, and valuations and are finding that the associated volatility is creating selective investment opportunities and shaping asset allocation decisions. Global central banks have embarked on monetary policy easing to support growth with more signs that further fiscal accommodation may also occur in the future. While the policy response has been supportive, the flight-to-quality mindset dominated the market.
Oil prices remain volatile as the pendulum swings between the implications for global demand as economies slow and supply disruptions/curtailments. The dollar has strengthened on relative U.S. economic performance and the Treasury curve continues to twist and shift broadly flatter and lower and some segments of the U.S. yield curve remain inverted. We believe that this change in the curve is more indicative of technical factors in the market rather than a looming U.S. recession and we will continue to monitor the incoming economic data to form our opinion.
Higher quality spread sectors performed well during the quarter led by corporate high quality and Yankee high quality securities. Given the change in U.S. interest rates, longer duration within most asset classes outperformed on a total return basis. Securitized sectors (asset-backed securities (ABS) and non-agency residential mortgage-backed securities (RMBS)), while still positive, lagged other sectors.
As expected, the Federal Open Market Committee (FOMC) lowered its target rate at both the July and September meetings to a range of 1.75-2.00%. The FOMC continues to reinforce its view that current policy is appropriate and that it will continue to act to support the economic expansion.
We continue to see value in spread sectors Policymakers are responding to the growth slowdown, which will be supportive over time; the U.S. consumer and housing markets remain on solid ground with unemployment low and wages growing; and corporate fundamentals appear broadly stable. In addition, as the stock of negative-yielding debt has swelled around the globe, the need for income has never been greater and underpins our strategy.
Contributors / Detractors
- The underweight to U.S. Treasury securities.
- Allocation to and issue selection within the corporate high quality sector. Technicals were supportive as positive fund flows continued and the pickup in supply (YTD running ahead of 2018’s pace) has been met with increased demand. Credit metrics have been broadly stable. Leverage and interest coverage metrics are fairly consistent relative to year-ago levels after a multi-year gradual deterioration.
- Issue selection within the corporate high yield sector. The technical environment remains supportive with a lack of issuance, the large volume of rising stars, and continued inflows leaving the HY market with a massive supply shortfall.
- Issue selection within high yield bank loans. Steady collateralized loan obligation (CLO) demand, lighter outflows, and rising repayments benefited the loan market during the quarter. Fundamentals in the sector, while supportive, have slowed. EBITDA growth, though still positive, has decelerated and credit conditions in the lower credit tiers are modestly deteriorating.
- Allocation to the ABS sector. The sector underperformed on a total return basis due to the shorter duration nature of the asset class.
Current Fund Strategy
Sector Changes: We reduced our exposure to ABS, high yield bank loans, and non-agency RMBS. We redeployed the sale proceeds primarily into U.S. Treasuries, Yankee high quality securities, and corporate high quality securities.
Non-U.S. Exposure: Over the quarter, we increased the overall non-U.S. and EM debt exposure within the Fund. We continue to have some concerns of macro headwinds for the sector, slowing global growth, and idiosyncratic risks, however, valuations in specific countries are attractive. The Fund’s non-U.S. exposure could receive uplift from positive global growth, weaker U.S. Dollar, supportive commodity prices, and accommodative monetary policy from major global central banks. In this space we favor sovereigns in larger capital structures, emphasizing high grade over high yield and hard currency over local market exposure.
Corporate High Quality: There continues to be value in corporate high quality; however, given the YTD spread tightening and current valuations we expect this sector to provide coupon-type returns, with modest room for spread tightening. We continue to favor the BBB segment of the sector and, from an industry perspective, favor banks, REITS, and basic materials. We are opportunistically repositioning our portfolios into a strong market ensuring our positioning continues to reflect our view on the best relative value within the sector.
Corporate High Yield: The corporate high yield market overall screened cheap at the end of 2018 with yields approaching the 8% area and spreads wider than historical averages. Newfleet was active in the market, trying to invest both in the new issue and secondary markets and looking to take advantage of both mispriced industries and issuers that were caught up in the selloff. After the strength YTD, we have been reducing names where valuations have run ahead of fundamentals and redeploying into names that have either not participated in the rally or have seen an improvement operationally. With idiosyncratic risk so high, correct industry and/or credit calls are imperative to outperforming in the space. Currently, we like the industries that both rely on the health of the U.S. consumer and are not as exposed to global trade.
Securitized Product: We continue to like our allocation to the securitized sectors (non-Agency RMBS and ABS), which offer a diversified collateral base and attractive valuations relative to many other areas of the fixed income markets. In addition, they offer diversification to the corporate credit allocation within the portfolio. Our consumer focus within the ABS sector has been beneficial as the U.S. consumer continues to show the ability to lift the U.S. economy. Non-agency RMBS benefits from steady income growth, full employment, good underwriting, and investor demand for mortgage credit.
We continue to look for opportunities in all sectors of the bond market, striving to uncover any out-of-favor or undervalued sectors and securities. We favor spread sectors based on sound fundamentals and a supportive environment for fixed income credit, including moderate economic growth, well contained inflation, and accommodative global central banks. We highlight the importance of credit selection and positioning in the current environment as valuations are generally fair. 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 see the best relative value and opportunities are: out-of-index/off-the-run ABS, RMBS, credit-specific high yield and high yield bank loans, investment grade corporates, and EM debt.
Newfleet Asset Management
AdvisorShares Newfleet Multi-Sector Income ETF (MINC) Portfolio Manager
Past Manager Commentary
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.
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.
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.
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.
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.
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.
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.
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.
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.
Spread is the difference between the bid and the ask price of a security or asset.
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.”
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 to change.
The views in this commentary are those of the portfolio manager and may not reflect his views on the date this material is distributed or anytime thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.