Ivy Securian Core Bond Fund
Commentary as of April 08, 2020
What are you seeing in the current market environment and how has the portfolio behaved? And obviously no one had a global pandemic in their scenario analysis, so how are you seeing the investment landscape in light of the recent environment?
Tom Houghton: On the positive side, it appears the COVID-19 curves are flattening in the U.S. and around the world. The Federal Reserve (Fed) and other central banks are pulling out all the stops to help stabilize the markets. For the first time, the Fed is buying investment-grade corporate bonds. The more liquid parts of our market have responded well to the global stimulus. On the negative side, it's clear that getting through this crisis is coming with a significant economic cost, and it's difficult to get a lot of confidence given the speed and magnitude of change.
Performance has started to improve, while liquidity has returned as has some rationality. We have argued that core fixed income should act as a ballast for investors, so from that perspective, we feel like we have underperformed. But that has come with a large degree of dislocation in credit markets. We’ve seen so many fear-driven trades, especially in the structured market. Levered non-agency investors have put pressure on our credit positions, regardless of rating or underwriting.
Big picture, we're seeing more rationality in the last week and performance reflects that.
Dan Henken: We do view ourselves as credit pickers as well as a core fixed income holding for an investor’s portfolio, which requires multi-sector exposure. We have those exposures, but correlations have moved much closer to one. These environments are going to be challenging for us. We were positioned for credit to have a weaker year. On Feb. 21, investment grade option-adjusted spreads (OAS) went from 99 basis points (bps) to 144 bps on March 6 – during this time we performed well. Then the fear-trade happened and OAS went from 144 bps to 373 bps and that stretch was challenging. Since March 23, spreads have started to tighten and our relative performance has been strong. Through this volatility, we have re-evaluated each of our credits to make sure we were comfortable with the exposures. We don’t see the benefit of building a portfolio that only fits 5% of the market experience. We will hang in the fight and give ourselves a chance to recover over the longer term.
What do you see in the opportunity set – are you looking to pivot the portfolio? For example, you've been underweight high yield relative to investment grade – can you make some incremental changes to the portfolio in this environment?
Dan Henken: There have been opportunities to capitalize on. We think normality has started to return to our market. The high-yield market is still largely broken from a new issue standpoint. So for us, this is really an investment-grade story, and the good news is these markets have re-opened and new issues have come back to market and we have been active there over the past two weeks. Widening in investment grade from spreads in the mid-300 bps range created opportunities and we have been fairly active. That has been a strong momentum trade with large capital structures with household names. On the flip side, we have been actively pruning some exposure where the investment thesis has changed, particularly in areas where the impact of COVID-19 is most likely to impact consumer behavior.
Lena Harhaj: The structured market has been a bit of a different environment. The structured issues take a little longer to bring to market, but a new deal hasn’t been priced since the beginning of March. We expect that to change once issuers start issuing under Term Asset-Backed Securities Loan Facility (TALF) 2.0. However, the secondary market has been pretty active. For example, short-AAA auto and credit card asset-backed securities (ABS) had spreads widen from mid-teen bps (pre-COVID-19) to 400 bps. Those spreads have come back to 100-200 bps depending on the credit. When new issues come it will be interesting to see the state of the consumer at that time and investors’ perceptions of it. Most of our positions are pointing to a seasoned deal, particularly in the credit-risk transfer (CRT) market. We’re looking at mortgages that were issued from 2014-2018, so there’s quite a bit of embedded home appreciation in those loans. Additionally, we went from 0.20% of government-sponsored entity (GSE) mortgage borrowers asking for forbearance to 2.66%. Stresses are expected at 10% levels on forbearance requests. CRT bonds went from par-to-$110 to $50-$60 prices. There were large funds liquidating positions putting pressure on those positions. They traded at stressed levels and have not recovered all of the negative return. We believe that will pan out as we see how the consumer gets through this crisis.
A big question is how long this stay at home sentiment persists – longer being worse for the consumer. If this extends, could you add value from fundamental research? Or, more broadly, how do you think about the risk of stay at home and how are you managing that dynamic?
Tom Houghton: Speaking briefly to the liquidity side of things, we did try to take advantage of some of those dislocations in structured markets, but dynamics of certain offerings limited our participation. The transparency in our markets isn't always perfect, but we're actively trying to take advantage of some of these depressed prices. When we think about stay at home, some industries will be impacted to a greater degree, like airlines. The airlines will continue to get governmental support, but this will be a bumpy ride.
What do you think it will take to close the gap on relative performance with the index?
Tom Houghton: We’ll need to see improvement in both the corporate and structured side of the portfolios, and that has been happening over the past couple weeks. CRT and non-agency securities made incremental improvements. On the corporate side, energy led the way down. Most of our exposure is in pipelines and refining, and we'll see much lower demand for gasoline over the next couple months, but people will return to driving when the economy opens back up. Taking advantage of things, we purchased bonds in this space recently. We are positioned in entities we feel are more volume-driven with less commodity exposure, which has bounced back over the last few weeks more so than exploration and production. We expect a continuation of these trends to close the gap versus the index.
You mentioned being positioned for a weaker 2020 – what do you mean by that?
Dan Henken: Corporate investment-grade credits exited 2019 with spreads inside 100 bps versus a post-crisis average of 140 bps. Over a 12-24 month period starting in 2018, we brought high yield down from double-digits to sub-5%. Corporate exposure was reduced from mid-50% to low-40%. Ninety-three bps was the tightest spread level of 2020, we expected that to leak out modestly wider and it did. In that period we outperformed. We are never going to be a manger that moves to 50-60% U.S. Treasuries – that’s not where we add value. So, we pruned the portfolio to be durable in a weakening reassessment of risk and it performed well. But then COVID-19 blew up at a rapid pace with social distancing creating flight-to-quality and a dynamic closer to what we saw during the Global Financial Crisis. We believe liquidity is starting to normalize, and while we don’t know the timeframe for full normalization, we know the Fed and government are committed to supporting the markets. We think this is early on, maybe one-third of the way of the retrenchment.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This informa¬tion is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. The views are current through April 8, 2020, and are subject to change at any time based on market or other conditions.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not in¬sured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Mortgage-backed and asset-backed securities are subject to prepayment risk and extension risk. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.