Fixed Income Insi from Weitz Funds
Another decade has passed and it should be noted that its last year was almost the opposite of its predecessor. Where 2018 was a year to be forgotten in terms of mediocre returns across almost every asset class (bonds, stocks, commodities, etc.), 2019 was a banner year. In 2019, stocks and bonds celebrated as they did in 1998. According to Dow Jones, 2019 marked the first time in more than two decades that major stock indexes have jumped at least 20% while benchmark returns the 10-year US Treasury has fallen three-quarters of one percent or more. Last year’s gains were even larger, with gold and oil prices rising more than 10%. The rise of 2019 – across a wide range of assets, from supposedly safe to risky – has not happened since 1984. Mitigating trade tensions, accommodating central banks, contained / low inflation, steady economic growth, Strong corporate earnings, a seemingly insatiable thirst for performance, and an overall risk mindset were some of the key elixirs that helped drive prices up in 2019.
Weitz’s equity and balanced funds posted impressive gains in the fourth quarter, capping excellent year-to-date results, both in relative and absolute terms. Please see Wally and Brad’s Quarterly Value matters commentary and equity and balanced funds Quarterly comments for a detailed analysis.
Despite maintaining a defensive positioning on credit and interest rates, Weitz bond funds also delivered strong results for the fourth quarter and full year. Further details on the contributors to performance can be found in the Quarterly Fixed Income Fund Commentaries.
The chart below shows the changes in some Treasury rates in the last quarter and the past year. Across the entire yield curve (a line that plots the yields / interest rates of bonds with different maturity dates) between the end of 2018 and 2019, interest rates fell by ‘about three-quarters of a percent.
U.S. Treasury Yields
Corporate bonds and other credit-sensitive securities posted another quarter of strong performance and kept pace with Treasury bonds as credit spreads continued to decline. A broad measure of investment grade corporate bond spreads, compiled by ICE BofAML, closed at 101 basis points as of December 31, 2019, down 21 basis points in the quarter and 58 basis points from the previous quarter. to a year ago. The graph below illustrates the evolution of investment grade credit spreads over the past five years (blue line) compared to the one (orange) and five year (gray) averages. Overall, corporate bond credit spreads are significantly lower than recent trends and very close to historic lows.
Investment grade credit spreads
Source: FRED Economic Data / St. Louis Fed
The price is what you pay, the value is what you receive
In the last quarter, we wrote that falling interest rates and falling credit spreads lead to increased investment risk. In other words, the price is what you pay while the value is what you receive. Continued declines in base interest rates (US Treasury) and credit spreads (corporate bonds) in the fourth quarter led investors to pay higher prices to receive less in the form of potential forward returns.
The table below gives a long-term view of the trends of the Bloomberg Barclays High-Grade Corporate Bond Index. While the last 10 years have been good enough for fixed income investors, in 2020 we are starting to experience increased interest rate risk as the maturity and option-adjusted term (ADO) are higher, and higher credit risk because the Option Adjusted Spread (OAS) is almost half of its starting point. The overall result is a Yield to Worst Return (YTW), which is well below what it was a decade ago and very close to its all-time low.
Bloomberg Barclays Index of U.S. Companies
The investment dashboard in which we monitor macroeconomic risk factors (fiscal, regulatory and monetary policies, inflation expectations, global interest rates, consumer debt, corporate debt health and investor sentiment) and fundamentals (credit spreads against long-term trends, yield spread to base US Treasury interest rates, and relative value opportunities across various asset classes) all flashed yellow (conservative), with a little red, over the last few months. None of this means that a recession is imminent or that spreads will become more attractive (wider) tomorrow, but it informs our process. Borrow a
Warren Buffett (Trades, Portfolio) a piece of wisdom: âWe want to be greedy when others are fearful and fearful when others are greedy. Â»A measure of fear, or lack of it, can be seen in the chart below that tracks the credit default swap index for investment grade bonds, which hit a low after the credit crunch in the last quarter of this year.
US Credit Default-Swap Index Trading After Credit Crunch
We intend to persevere in our search for investment opportunities. We spent 2019 interviewing dozens of new issuers across all sectors and industries (corporate, asset-backed, trading, mortgages), some leading to significant investments for our funds, but all of them draw on the tapestry of information that we can draw on in the future. As we move into a new decade, we will continue to focus on the things we can control: fundamental analysis, security selection, favorable risk-adjusted return profiles, and consistent, in-depth credit monitoring. We understand that our competitors are arguably just as smart, but we hope to continue to create sustainable sources of competitive advantage by learning faster, communicating more effectively, failing less, and waiting longer (yes, patience. is a virtue) for the right opportunity.
The opinions expressed are those of Weitz Investment Management and are not intended to be investment advice or to predict or project the future performance of any investment product. Opinions are current until 1/10/2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is provided as a source of general information and is not intended to be a recommendation to buy, sell or hold any specific security or to engage in any investment strategy. Investment decisions should always be made on the basis of the investor’s specific objectives, financial needs, risk tolerance and time horizon.
Past performance is no guarantee of future results. All investments involve risk, including possible loss of capital.