High Grade Core Intermediate 1st Quarter 2013
During the first quarter of 2013, Samson’s High Grade Core Intermediate Strategy outperformed both the Barclays Intermediate Aggregate, and the benchmark excluding the riskier sectors we avoid as a conservative investor. We did it in a risk managed fashion, as we shall discuss in greater detail below. It was a quarter when bond risk was widely discussed, but although the subject made its way into scary headlines about a “bond bubble,” it did not make its way into bond prices in any serious fashion.
The sad fact for high quality investors is that Treasury yields are low and likely to stay there until the economy can reach escape velocity from the credit crisis and the Great Recession that followed. Accommodative central bank policy, slow growth, low inflation, and fiscal headwinds explain much of the downward pressure on interest rates. We have kept our Treasury exposure minimal and portfolio durations modestly shorter than the benchmark because of our macro forecast and real rate analysis, not due to any near term concern about a “bond bubble” bursting. The good news is, as we pointed out in our previous commentary, that there is not necessarily a penalty for managing portfolios in a conservative fashion. In fact, our non-index allocation to quality municipals gave us a yield advantage that helped us outperform the riskier index.
There are other reasons for our deep underweight to Treasuries. Despite the headwinds and uneven recovery, we think the economy will prove to have grown more resilient to the Spring and Summer shocks we have experienced the past few years. Problems in Europe persist, but we believe the threat to the common currency has diminished with a rescue fund in place and policymakers able to lower bond spreads by reiterating their commitment to keeping the euro together. The most recent US non-farm payroll figure was a disappointment, as seen at right, but the trend in employment growth remains positive. While the growth trajectory of the recovery has become more uncertain, we don’t believe recession is in the cards either. We prefer to overweight municipals and agency MBS and stay neutral to corporates as we find these markets the most attractive options in our high quality toolkit. Even if growth stays anemic, the yield advantage of these sectors gives us confidence that our strategy will provide reliable returns.
As the sector returns to the right demonstrate, the best investment grade opportunity during the first quarter was tax-free municipals as represented by the Barclays 5-Year Municipal Bond Index. This is a high quality sector that we believe often flies under the radar of mutual fund alternatives, who may be restricted to the benchmark’s sectors. We rely on the independent credit research of our municipal staff and can express meaningful overweights to the sector that larger, passively managed funds cannot. This has been to our clients’ benefit.
Municipals continue to benefit from improving tax receipts and low supply. AAA rated municipals continue to offer higher yields than comparable-maturity Treasury bonds. Historically, municipal/Treasury yield ratios above 100% have been a buy signal and we will maintain the overweight until the ratio normalizes. It is fair to ask if the focus on ratios is only one side of the argument: of course, municipal credit quality and the value of the tax exemption remain important considerations, but our holdings are independently screened to identify the most liquid and secure issuers in the market. The exemption remains a political football in Washington, but given the stark differences between the parties on tax policy, any adjustment in the near term is unlikely.
Our strategy is underweight Treasuries, overweight municipals, and overweight mortgage backed securities (MBS) with a preference for GNMAs. We do not doubt that FNMA and FHLMC guaranteed securities are high quality, but we do worry about policymakers enacting large scale changes without thinking through the effects on the secondary market. In the meantime, we believe staying overweight a low volatility, high Sharpe ratio sector, during what we believe will be a trading range environment, is a sensible way to generate steady returns for our clients.
And corporates? Well, we do believe they are overvalued from a spread perspective, as shown in the chart to the right, but our credit work shows healthy balance sheets and steady to improving fundamentals on many levels, despite the recent deceleration in earnings. Essentially, the impact of tight spreads and steady fundamentals offset each other in our view, and we maintain a neutral allocation to the sector.
Let us return to the subject of the bond bubble and real interest rate analysis. As the chart to the right shows, when we look at 10-Year Treasuries from the perspective of what you keep after inflation, the real interest rate, we are near historic lows. But, it is not inevitable that interest rates must go up to resolve this overvaluation. The other alternative is for inflation to fall. If 10-year Treasury yields remain steady, but CPI falls, real interest rates will turn positive.
The charts on the next page highlight the experience of the Japanese government market in recent years. Let’s travel back to June 30th 2008, that long forgotten time when there was inflation in Japan. Back then, Japanese CPI was 2%; Japanese Government Bonds (JGBs) were yielding about the same, and real interest rates were approximately 0%. Let us agree 0% is a low number and seems like a poor investment opportunity. Yet, as we all know too well, financial calamity ensued, inflation became a dream as deflation took hold, and although the nominal yield of JGBs fell modestly, the real yield of JGB’s actually rose. While we do not believe that the U.S. will follow Japan’s example, this vignette highlights the fact that a bond market overvaluation is not always resolved by rising interest rates.
We don’t believe the word “bubble” is an accurate description of the bond market today. If bubbles are driven by greed, the real rates analysis shows the level of Treasury yields is primarily driven by fear as investors are willing to accept negative real returns with limited price appreciation at current levels. As conservative, value oriented investors, we pursue an active sector rotation strategy to manage the interest rate risk that will come from higher rates, rather than keeping high cash balances. We believe that the sectors we have chosen to overweight were purchased at attractive spreads, and should provide cushion in a rising rate environment, unlike Treasuries.
Chief Investment Officer
April 25th, 2013
No representation or assurance is made that Samson High Grade Core Intermediate Strategy will or is likely to achieve its objectives, or will make a profit or will not sustain losses. Any statements regarding future events constitute only subjective views or beliefs, are not guarantees or projections of performance, should not be relied on, are subject to change due to a variety of factors, including fluctuating market conditions, and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified and are beyond our control. Future results could differ materially and no assurance is given that these statements are now or will prove to be accurate or complete in any way. Samson does not provide tax, accounting or regulatory advice. ANY TAX STATEMENT CONTAINED HEREIN IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED BY ANY PERSON, FOR THE PURPOSE OF AVOIDING TAX PENALTIES.
Past performance is not indicative of future results. Performance reflects the reinvestment of income and other earnings. Any benchmarks or indices shown are for illustrative purposes only, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit or other material characteristics (such as number and types of securities) that are different from (HGCI). Certain information is based on third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. This information is confidential, is intended only for intended recipients and their authorized agents and may not be distributed to any other person without our prior written consent.
N.A. – Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year or lack of a full year or full three years of performance.
1) Definition of Firm: Samson Capital Advisors LLC (the “Firm”), founded in June 2004, is an SEC registered investment adviser as of May 2004. Samson provides investment management services.
2) Compliance Statement: Samson Capital Advisors claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Samson Capital Advisors has been verified for the periods June 1, 2004 through December 31, 2008 by Ashland Partners & Company LLP and from January 1, 2009 through December 31, 2011 by The Spaulding Group.
Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. The High Grade Core Intermediate Composite has been examined for the periods December 31, 2004 through December 31, 2008. The verification and performance examination reports are available upon request.
3) Policies: Additional information regarding the Firm’s policies and procedures for calculating performance, valuing portfolios, and preparing compliant presentations is available upon request.
4) Composite Description: The High Grade Core Intermediate Composite was created September 30, 2005. The Composite consists of all fully discretionary, fee paying separately managed accounts in the High Grade Core Intermediate style. The High Grade Core Intermediate strategy is a relative return focused mandate appropriate for investors with an indefinite investment horizon, seeking to maximize return with a lower degree of principal volatility than typical aggregate market strategies. The minimum account size for this composite is $2.5 million.
5) Benchmark: For comparison purposes, the composite is measured against the Barclays Capital Intermediate Aggregate Index.
The Barclays Capital U.S. Intermediate Aggregate Index is an unmanaged index that represents the U.S. domestic investment-grade bond market. It is comprised of the Barclays Capital Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, including securities that are of investment-grade quality or better, have at least one year to maturity, and have an outstanding par value of at least $100 million. Please note that indices do not take into account any fees and expenses of investing in the individual securities that they track and that individuals cannot invest directly in any index. Data about the performance of these indices are prepared or obtained by NBM and include reinvestment of all dividends and capital gain distributions.
6) Reporting Currency: Composite returns are expressed in U.S. dollars.
7) Fees: Gross-of-fees returns are presented before management fees, but net of all trading expenses, and withholding taxes. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The collection of fees produces a compounding effect on the total rate of return net of management fees. As an example, the effect of investment management fees on the total value of a client’s portfolio assuming (a) quarterly fee assessment, (b) $1,000,000 investment, (c) portfolio return of 8% a year, and (d) 1.00% annual investment advisory fee would be $10,416 in the first year, and cumulative effects of $59,816 over five years and $143,430 over ten years. Additional information regarding the policies for calculating and reporting returns is available upon request. The management fee schedule is as follows: 0.40% on the first $10 million, 0.30% on the next $10 million, and 0.25% thereafter. Actual investment advisory fees incurred by clients may vary. Net-of-fee performance is show net of model management fees (the highest charged to an account in the composite), all trading expenses, custodial fees, and withholding taxes.
8) Significant Flows: The composite policy requires the temporary removal of any portfolio incurring a client initiated significant cash inflow or outflow of at least 15% of portfolio assets. The temporary removal of such an account occurs at the beginning of the month in which the significant cash flow occurs and the account re-enters the composite at the beginning of the month, after full investment.
9) Internal Dispersion: The measure of dispersion used in this presentation is the asset-weighted standard deviation of annual gross-of-fees returns of those portfolios that were included in the composite for the entire year. This calculation measures the fluctuation of the rates of return of portfolios with the Composite in relation to the average return. Dispersion is not shown for composites with 5 or fewer portfolios for a full year.
10) List of the Firm’s Composites: In addition to the Composite, the Firm provides investment management services utilizing different strategies. A complete list of composite descriptions is available upon request.
11) Additional Disclosures: As of 7/1/09 portfolios are revalued for cash flows of 10% or more. Prior to 7/1/09 portfolios were not revalued for large flows.
Benchmarks are shown for illustrative purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the Strategy. Information is as of the date hereof unless otherwise indicated. Certain information is based on data provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. This information is confidential, is intended only for intended recipients and their authorized agents and may not be distributed to any other person without the Manager’s prior written consent. Notwithstanding and foregoing, the recipient and their authorized agents may disclose to any and all persons, without limitation of any kind, the structure and tax aspects of the transactions described herein and all materials of any kind that are provided by Samson to the recipient related to such structure and tax aspects.
Beginning January 1, 2008, the composite definition was expanded to include accounts with mandates that allow for investment in securities which do not fall within the High Grade Core Intermediate style. For example, the mandate may allow for allocations to alternative sectors or an extension in duration outside the acceptable boundaries of the High Grade Core Intermediate style. At their time of inclusion, these portfolios had no allocation to these securities. Should these portfolios become invested in these securities, they will be removed from the composite.