FolioBeyond Fixed Income Commentary For April 2021
Performance Summary
FolioBeyond's algorithmic Fixed Income strategy returned +0.74% and +0.37% in its dynamic and static volatility versions, respectively, in April. The strategies generally kept up with the modest rebound in the broader Fixed Income markets during the month. Year-to-date, our strategies have outperformed the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") by 199 to 265 bps.
The market settled into a trading range in April with the 10-year Treasury yield retracing part of the previous month’s increase and ending the month 9 basis points lower. Consequently, the 2 to 10-year yield spread flattened by 9 basis points as the 2-year Treasury remained unchanged. The positive performance of our strategies in April, while protecting the downside in a steepening selloff earlier in the year, demonstrates the value of our multi-factor optimization approach.
Source: FolioBeyond’s returns are from SMAs on Interactive Brokers (from January 1, 2019 for Static Volatility and from November 3, 2020 for Dynamic Volatility) and back-tested simulated results prior to that. AGG and Multisector Bond Category returns are from Morningstar.
* FolioBeyond Dynamic and Static Volatility returns are net of underlying ETF fees and 30 bp assumed management fee. Although the information herein is believed to be reliable, FolioBeyond makes no representation or warranty as to its accuracy, and information and opinions reflected herein are subject to change at any time without notice. The past performance information presented herein is not a guarantee of future results.
Highlight: Customization Using Multi-Factor Approach
FolioBeyond’s modeling framework lends itself well to effective portfolio customization using proper multi-factor analytics. The major components of our modeling approach include forward-looking relative value analytics, quantification of risk with adjustment for current implied volatility, correlations, momentum effects, and stress testing. Our standard portfolio models target the volatility of AGG with the goal of outperforming the index by 100-200 basis points annually over intermediate to long-term holding periods. This type of exposure can serve as a core Fixed Income portfolio or a complement to an existing bond portfolio since it exhibits low correlation to standard benchmarks.
The model can also be applied for various customized application, utilizing both ETFs and individual bonds. The requirements include proper modeling of the value and risk characteristics of instruments, and availability of sufficient historical data points. A sampling of model applications is discussed below.
Rising Rates Strategy: MBS Interest Only Strips (IOs) can be combined with Treasuries to provide a compelling bearish Fixed Income portfolio that offers upside protection under rising rates while providing current income in an unchanged market environment. MBS IOs have a unique feature of offering current income with negative duration. This type of portfolio construction, however, requires significant MBS expertise to manage and optimize the allocations within desired duration and risk targets. This strategy is currently being offered for separate accounts and will be available as an ETF later this year.
Income Focused Hybrid Strategy: Some investors are reaching for higher current income by exploring opportunities in hybrid instruments such as preferred stocks, business development companies (BDCs), MLPs, and property REITs. While these strategies provide higher current income than most Fixed Income sectors presently, they come with added equity and equity-like risk. FolioBeyond’s framework can be utilized to incorporate both components of risk in hybrid instruments. A higher yielding portfolio with a defined risk target can be optimized using a combination of Fixed Income and hybrid instruments. Given proper quantification and management of the blended portfolio, the risk/return profile of this type of portfolio can be evaluated alongside investors’ equity holdings.
Duration Targeting: Target maturity funds and strategies have been popular, especially in retirement accounts. One of the challenges investors have faced is the unexpected volatility of certain types of target date strategies as you get closer to the maturity date. Using our framework, target maturity portfolios can be managed to a declining duration target with volatility being reduced over time as you approach the maturity date. The desired glide path can be properly implemented within our optimization framework.
There are also a variety of other applications such as the construction of diversified portfolios with minimum ESG scores, insurance targeted portfolios that capture NAIC’s risk-based capital constraints, and short duration income strategies, to name a few. Please contact us to explore how our standard and customized portfolio solutions can enhance your overall Fixed Income portfolio.
