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Tides Turning: Fixed Income Solution for Rising Rates

Redwood launched the Redwood Flexible Bond Class at the end of April and has raised $40 million in its first month of operation.  The fund started investing on the first week of May, and finished the month at a net asset value per unit of $10.21 representing a solid positive return in its first month of investing.

The fund’s performance sits in stark contrast to many other funds investing in bonds, over the course of the month.  While it is not wise to compare one month’s worth of performance, we do believe that some of the market conditions that prevailed in May, could be part of a broader trend towards higher nominal rates over the next few quarters and years – a trend that could seriously damage the portfolios of bond investors.

With hope of improved economic activity in the US, 10 year treasury bonds yields increased to over 2% for the first time in over a year, reminding investors that even small increases in yields on longer dated bonds, have a significant negative price impact.

Select Bond Performance In May.

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Bond funds were impacted by three key factors in May.  1) Duration – rising rates, cost investors’ money, as bond prices decline.  2) Currency, funds with USD exposure benefitted as the C$ declined.

High yield bonds averages declined by between 1.5-2% over the course of the month of May.

The NEW Trend Is Not Your Friend in Bonds

Bonds have been a very comfortable place to be over the last 30 years, as we have seen a tremendous downdraft in rates lead to excellent long-term bond returns.  If we look back further, however, we can see that the last 30 years were preceded by significant increases of rates in the post-WW2 period.

The chart below shows that bonds are volatile.  Much more volatile than many investors realize.  Adding to potential volatility, is a study out of US firm Casey, Quirk & Associates estimating that over the next 3-5 years, over $1 trillon – 13.5% of the capital currently invested in fixed income by professionals – will leave the bond market.

The Casey Quirk White Paper can be read in its entirety, here. “When the Tide Turns: Building Next Generation Fixed Income Managers”

Bondhistory

Reams Asset Management have an excellent long-term track record – and its one they have amassed by reacting to volatility in the market.  Based on the Reams Unconstrained Insitutional Mandate, the Redwood Flexible Bond Class, benefits from a full tool kit of strategies and securities to actively manage the following:

  1. Duration and Yield Curve – the fund currently has a negative bet on duration with the overall portfolio having a negative 2.5 year duration
  2. Sector and Bond – the fund is favouring high quality corporate bonds, with relatively short durations.
  3. Risk Oversight and Controls – allowing the fund to actively add or reduce positions based on macro and micro viewpoints to effectively manage risk.

For more information on how the Reams Unconstrained Mandate has performed in periods of rising rates, please contact us at invest@redwoodasset.com

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