FolioBeyond Fixed Income Commentary For June 2021
Performance Summary
FolioBeyond's algorithmic Fixed Income strategy returned +0.32% and +0.24% in its dynamic and static volatility versions, respectively, in June. Year-to-date, the strategies have outperformed a comparable risk benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG"), by 154 to 218 bps.
The Treasury yield curve flattened as hints of tapering by the Fed reversed some of the earlier moves in the bond market. The spread between 10-year and 2-year Treasury yields declined by 19 basis points as the 10-year yield fell by 13 basis points while the 2-year rose by 9 basis points. Our strategy returns in June were primarily generated from short duration high yield corporate debt exposure but lagged the AGG benchmark due to the shorter overall portfolio duration.
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: Dynamic Model Rebalancing
The current macro environment is characterized by uncertainties related to the strength of the economic recovery, transitory versus persistent inflationary pressures, the timing of Fed’s gradual withdrawal of liquidity, and other economic drivers that may be at inflection points. While the momentum effect might resurface as longer-term trends get established, the current picture is less clear, with the exception of shorter-term directional moves. However, specific longer-term themes are likely to develop but are harder to time and pinpoint with accuracy. Given this backdrop, we provide a mid-year recap below of how our model has navigated the markets.
We started 2021 with a sub 1% yield level on the 10-year Treasury. As general sentiment developed that was rife with optimism for economic recovery along with associated concerns regarding creeping inflation, our multi-factor model positioned the portfolio with a shorter duration than the AGG index but produced better income by allocating to short-dated high yield Corporate Bonds and Bank Loans. As the market sold off at the long end of the Treasury curve, our portfolio was consequently less exposed. Along the way, we also continued to stress proper risk management and the importance of quantifying the various dimensions of risk ranging from spread duration to option and credit risk to correlation and volatility risk.
As the Treasury yield curve steepened further, our model extended duration for a short time period as it captured the benefits of higher yields on long Treasuries vis-à-vis its higher duration risk. As CPI expectations continued to ratchet up, Treasury Inflation Protected securities (“TIPs”) became more attractive, and the model started allocating to a mix of short and long TIPs. Subsequently, this exposure was increased further, focusing on long TIPs. At the current time, High Yield Corporate Debt has been removed in favor of a modest allocation to Bank Loans, while Treasury exposure is minimal with government credit exposures being concentrated in US Agency debt and TIPs.
The sectors that have not been allocated to this year in our portfolio include Investment Grade Corporate bonds, long duration High Yield Corporates, Emerging Market debt, Municipals, and Mortgage REITs. Some of the higher yielding sectors such as mortgage REITs can undoubtedly add value to a diversified portfolio given higher risk tolerances. For higher risk hybrid portfolios that include Preferred Stocks and BDCs, our multi-factor modeling approach has been customized to generate portfolio solutions that target higher income with risk levels halfway between traditional bonds and stocks.
Outside our current universe of 23 sector ETFs, there are a number of missing sectors that should provide additional diversification benefits. We are currently working on a rising rates strategy ETF as well as an Investment Grade CLO ETF with institutional partners to fill in the gaps in the Fixed Income sector ETF space.
New market developments lead to changes in relative value relationships and risk factors embedded in bonds. A dynamic and efficient approach to portfolio rebalancing should lead to better portfolio results with higher Sharpe Ratios over time. It is the application of a consistent portfolio management approach that will be more enduring and less prone to unexpected results. FolioBeyond’s multi-sector optimization framework is designed to produce a comprehensive, objective portfolio solution that automatically captures the major drivers of risk and return in the Fixed Income market, with different customization dials to create solutions that match investors’ goals.
Our model portfolios are available on Folio Institutional, Boutique Exchange, and as a S-Network FolioBeyond Optimized Fixed Income Index on SMArtX and C8 Technologies. Please contact us to explore how our portfolio solutions can fit into your overall Fixed Income allocation.
