High Grade Core Intermediate 4th Quarter 2013
2013 Review and 2014 Outlook
In a turbulent year for taxable bond strategies, Samson high grade strategies generated returns consistent with their benchmarks across the yield curve:
- High Grade Short Term Strategy: designed for risk averse investors concerned about rising rates, generated a positive return for the period well in excess of cash.
- High Grade Core Intermediate Strategy: for investors seeking broad exposure to Treasuries, corporates, and mortgages, generated low volatility returns with a quality and liquidity focus.
- Intermediate Government Strategy: for investors who do not want to compromise on credit quality, but are concerned about expressing this view through an undiversified US Treasury portfolio. This strategy offered an enhanced return though allocations to various other government supported credits.
Over the past year, we implemented the following investment themes across all high grade strategies:
- To reduce volatility, exposure to Treasuries was held under benchmark weights through-out much of the year. At the start of 2013, we viewed US Treasuries as the most vulnerable sector of the market. Treasuries were overvalued on a real yield basis and so we began the year with a deep underweight to the sector. As rates surged in the latter months of the year we increased Treasury exposures, though we remain at allocations below the benchmark weights. Treasuries underperformed the broader markets throughout the year.
- To enhance yield and total return, we entered the year with an overweight to corporate bonds and maintained that focus throughout 2013. As the economy gained traction and earnings remained healthy, spreads compressed and corporates outperformed, as can be seen in the index data to the right. In our government strategy, we reflect a favorable view towards spread sectors like corporates by purchasing US dollar denominated sovereign bonds issued by credits like Canada or Sweden, as well as the debt of certain multilateral issuers like the World Bank or the Inter-American Development Bank, whose bonds are backed by many sovereign nations.
- Opportunistic allocations to tax-exempt municipals, at yields superior to Treasuries, supported our up-in-quality bias and reflect our orientation as a value manager. Municipals were cheaply valued at the start of the year. Retail mutual fund selling weighed on the market at times, but favorable supply/demand imbalances, supported by a drop in issuance and a decline in selling pressure, supported richer municipal valuations later in the year. Though we have begun to reduce our exposure to the sector, we have maintained an allocation in place of overvalued agencies and Treasuries. In our government strategy we express our favorable view towards municipals using only prerefunded municipals backed by Treasuries, essentially an arbitrage where we are buying Treasury-backed credits with yields above Treasuries.
Mortgage backed securities, with favorable cash flow characteristics and attractive yields and valuations, played a role in all of our strategies. Our overweights to this sector were generally a drag on returns as the fear of rising rates combined with the sector’s negative convexity features resulted in underperformance. In our government strategy, we only use GNMAs, in keeping with our conservatism in this strategy, utilizing our long-term approach to purchasing pools with prepayment features broadly in line with coupon cohorts. While sector returns were disappointing, across all of our strategies our agency MBS pools behaved as expected and generated prepayment rates consistent with our objectives.
- Our yield curve strategy was tilted towards a barbell across all strategies. We view curve slope in the context of our statistical rich cheap analysis and through the framework of our fundamental outlook for the economy and the Fed’s policy. We concluded the curve was too steep for this stage of the recovery, and expectations of Fed tightening and tapering too great. As we moved towards a barbell, the curve steepened further, and created a drag on performance. However, with curve slopes near all-time steepness, we continue to target a more barbelled structure.
Our firm outlook is for an economy that will continue to muddle along with a mild recovery and limited inflation pressures.
- We believe the markets will continue to swing between fear about a stock market swoon and optimism about the economy and stocks, and Treasuries will be buffeted by that volatility. We expect to stay underweight Treasuries and overweight corporate bonds. Even though spreads have narrowed, we find the breakevens are still attractive, and while the best days for earnings growth may be behind us, corporate balance sheets are in great shape.
- As we believe the Fed will remain accommodative under the new Federal Reserve chairperson Yellen, we remain comfortable overall with spread allocations, though we will be mindful to use our traditional rich/cheap analysis to sector rotate away from overvalued sectors, just as we did in 2013. We believe the Fed’s assertion that the tapering program will be data dependent and we will be watching the data carefully as a fundamentally oriented manager.
- While municipals have richened relative to other sectors recently, we remain impressed with the improving credit fundamentals of the sector and are mindful that in a rising rate environment this sector typically holds its value better than taxables. As a result, should the sector continue to richen, we are likely to reduce our exposure more slowly than valuations by themselves might suggest, as we do expect rates to rise modestly. We also expect low municipal supply to support the sector’s continued outperformance despite richening ratios. The absolute supply of municipals is falling, and it is the only tax free game in town.
- While we do not believe inflation will surge in the immediate future, we have built TIPS exposures in our longer duration strategies as an insurance policy. The Fed’s goal is higher inflation, and we would like some protection in case they achieve their mission. We have not bought TIPS for our High Grade Short Term Strategy due to the negative real yields in those maturities. This insurance policy, like most, was a premium that we paid to avoid risk. Inflation did not materialize in 2013, and our TIPS allocation was a drag on performance.
- Washington leadership seems to have learned its lessons from the last budget showdown, so we are hopeful that this problem is off our radar for 2014, but we are mindful old habits die hard and will take action as needed.
- Among the reasons we believe the economy will continue to muddle along, is that, although tax rates have risen, creating a drag on consumers, we do not expect them to go up again this year. The budget deficit has shrunk considerably since last year, so although the sequester remains in place, the drive for further austerity is likely moderating – especially as we head into an election year. Job creation had been resilient (at least until the December non-farm payrolls came in at 74,000), if at a slower pace than some would like, and the wealth effect of a stock rally combined with improving home values supports continued growth.
- In this context, to the extent we maintain durations closer to the benchmark, rather than materially shorter, it reflects our view that rates are closer to an intermediate top than a bottom. However, our views are informed less by a directional view regarding rates, than our complete security analysis which includes our assessment of spread movement, roll down, and curve slope changes. Our view is that if a rate rise occurs, it will be muted, and we expect that all of our strategies are likely to generate healthy returns if our outlook for a muddle along economy holds true. If data accelerates, however, we will be responsive and adopt a more defensive position to mitigate the impact of a sharply rising rate environment.
As a firm, we are continually looking to develop strategies that offer value for clients. We are currently developing a diversified closed-end taxable bond fund strategy. This approach is specifically designed for non-taxable entities interested in enhancing yields. We intend to screen for undervalued closed-end taxable bond funds which are chosen based on their risk and liquidity characteristics. We would seek to extract the value presented by the premium/discount cycle that regularly appears in the closed-end fund universe through a statistical rich/cheap analysis. Our intention is to introduce this closed-end taxable bond fund strategy over the next few weeks. Please stay tuned for our upcoming webinar.
Chief Investment Officer
January 16, 2014
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, HGST, and IG. 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.
No representation or assurance is made that Samson Strategies will or are likely to achieve their 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.
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 Descriptions: The High Grade Core Intermediate (HGCI) 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.
The High Grade Short Term (HGST) Composite was created January 31, 2012. The Composite consists of all fully discretionary, fee paying separately managed accounts in the High Grade Short Term style. The strategy is a relative return focused mandate appropriate for investors with an 1-3 year 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.
The Intermediate Government (IG) Composite was created January 1, 2014. The Composite consists of all fully discretionary, fee paying separately managed accounts in the Intermediate Government style. The strategy is a relative return focused mandate appropriate for investors with an indefinite investment horizon desiring exposure to government supported credits. The minimum account size for this composite is $2.5 million.
5) Benchmark: For comparison purposes, the HGCI 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.
For comparison purposes, the HGST composite is measured against the Barclays Capital 1-3 Year Government/Credit Index.
The Barclays Capital U.S. 1-3 Year Government/Credit Index is an unmanaged index that represents the U.S. domestic investment-grade government and corporate bond market. It is comprised of the Barclays Capital Government and Credit Indices, including securities that are of investment-grade quality or better, have between one and three years to maturity, and have an outstanding par value of at least $250 million.
For comparison purposes, the IG composite is measured against the Barclays Intermediate Government Index. The Barclays Intermediate Government Index is an unmanaged index that represents the U.S. government bond market. It includes securities that are of investment-grade quality, have at least one year to maturity and have an outstanding par value of at least $250 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. Model fees are being deducted on a monthly basis.
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.
Past performance is no guarantee of future results and may differ in future time periods.
Beginning January 1, 2008, the HGCI 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.