High Grade Core Intermediate 3rd Quarter 2013
During the 3rd quarter, our High Grade Core Intermediate (HGCI) strategy generated a 1.00% return, which compares favorably to the 0.76% return of the Barclays Intermediate Aggregate and the 0.73% return of the Intermediate Aggregate excluding the types of securities we do not purchase for this strategy (BBBs, CMBS, ABS). As noted in our July commentary, although the bond market embraced the view that the Fed would taper, reducing its purchases of Treasuries and mortgage-backed securities (MBS), our data driven fundamental approach led us to the opposite conclusion. We stayed focused, as did the Fed, on the unemployment and inflation rates. We concluded that, as both rates were far away from the Fed’s stated targets, the Fed would not taper meaningfully, and, ultimately, the yield curve would flatten substantially. Additionally, we reasoned that in an environment where Fed tightening was pushed out to the future, spread sectors would benefit. Our sector and yield curve strategies for the quarter were directly linked to this outlook and drove our outperformance.
From a sector allocation perspective, it is important to note that we entered the quarter with a deep underweight to Treasuries and maintained that position throughout the quarter. This reflected not only our view that Treasuries were overvalued relative to other sectors, but also our conclusion that spread sectors would outperform Treasuries if the Fed tapered less than the market expected. As the table to the right shows, not only were Treasuries the worst performing sector in the benchmark, municipals, which represented our most significant overweight, were among the best.
Our out-of-benchmark allocation to municipals continues to play an important role in our strategy on a variety of levels. As the ratio chart to the right shows, municipals continue to trade cheaply versus Treasuries, allowing us to add a high quality source of low volatility yield to the portfolios. Municipal/Treasury ratios fell towards the end of the quarter and generated meaningful outperformance. As the comparison between our portfolio and the index portfolio below shows, municipals continue to make a meaningful contribution to our duration, and to the relatively attractive portfolio yield.
Though our portfolio is much higher quality than the benchmark, the yield remains very competitive. Municipals also play an important diversification role. We believe they are the new safe haven. Despite the headlines about Detroit and Puerto Rico, we believe municipal issuers across this country are doing a great job, credit is improving, and they were open for business while Washington was closed. We have never felt better about this position and will continue to overweight it.
Regarding yield curve positioning, we entered the quarter with a moderate barbell and moved increasingly towards that position as the quarter progressed. As the chart to the right shows, the curve steepened in the first 2 months of the quarter and flattened aggressively in September. We modestly extended the duration of our portfolios and increased our barbell yield curve position when the yield curve was near its steepest slope of the quarter, at a statistical extreme. This quantitative data, combined with our fundamental view regarding Fed policy, gave us the conviction to increase our barbell positioning as can be seen in the comparative maturity distribution and key rate duration charts at right.
Janet Yellen has been nominated to replace Ben Bernanke as Federal Reserve chair. This has always been an important job as other central banks take their policy cues from the Fed. And given the gridlock in Washington, the Fed has had to take a solitary role in stimulating growth. Monetary policy has had to fill the void left by a contractionary fiscal policy. We expect, based on her history, that Yellen will be at least as dovish as her predecessor. The Fed was careful to explain the delay of the taper in terms of the economy not yet reaching its targets, rather than any great fear that a recession was imminent. It is also worth noting that the Fed does not view tapering as tightening monetary policy, as they expect to keep their target rate anchored for the foreseeable future, even after bond buying ends.
Dysfunction continues to reign in Washington. Political leaders could not avoid a government shutdown on October 1st and went down to the proverbial eleventh hour to lift the debt ceiling. It is unfortunate that our leaders cannot find compromise and insist on lurching from crisis to crisis. The current agreement kicks the can down the road until early next year. That means, like the Halloween movies, Jason…..we mean the political squabbles, will be back.
While some financial markets took Washington discord in stride, not all sectors were so complacent. While there was no meaningful correction in the stock or bond markets, T-bills maturing around the time the Treasury Department expected to run out of funds saw their yields rise significantly. True, this had to do with liquidity concerns about payment being delayed rather than an extended default, but this was just another data point to add to a growing list that the U.S. is not the global financial leader of times gone by. Perhaps that is why the Hong Kong Exchanges and Clearing, an agency that governs futures trading and equity markets, announced that it will haircut U.S. Treasury collateral by a bigger amount when investors post it as collateral for margin. The haircut was tripled from 1% to 3% for shorter maturities. The Hong Kong Monetary Authority, which acts as the territory’s central bank, explained matters clearly: “in the unlikely event a U.S. debt default takes place, there could be disruptions to financial market operations and shockwaves to the global financial market.” Hong Kong was not alone. The head of the IMF, Christine Lagarde, expressed deep concern and noted that Washington gridlock and even a brief default would cause a “lack of trust” in the U.S., and “massive disruption the world over.”
Despite the short-term resolution, based on the government’s own projections, the debt bomb continues to tick, and, thanks to the short-term solution, markets have resumed their complacency. The complacency may not last though.
As uncertainty rises, greater diversification across asset classes is warranted. Our portfolios are diversified from a sector perspective, underweight the Treasury sector that concerns us the most, and are positioned to benefit from a Federal Reserve that will likely be dovish for a long time. Bernanke may retire but his measures to stabilize the economy and resuscitate employment could live on. This should be good for spread sectors, and eventually TIPS – a sector allocation we increased during the quarter.
Markets may yet face more instability, but these portfolios are positioned for the road ahead.
Chief Investment Officer
October 23rd, 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 of performance. 3 Year Standard Deviation data is not available because 36 months of returns does not exist for the time period indicated.
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 claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Samson has been independently verified for the period June 1, 2004 through December 31, 2008 by Ashland Partners & Company LLP and from January 1, 2009 through December 31, 2012 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 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.
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 cash 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.