“It is easy to toss out a bunch of negative prefixes. Unprecedented, dislocated and non-functional pretty much describes the market for fixed income securities at this point in time.” Those were our words that began our commentary for the third quarter of 2008, and over the quarter found history once again repeating. The first quarter of 2020 began with strong returns for risk assets, only to end in the quickest meltdown experienced in our lifetimes. Global policy-making bodies continue to make unprecedented moves, announcing a host of steps to combat the spread of COVID-19 and minimize, as much as possible, the economic fallout. The last few weeks have been a period of enormous volatility and limited visibility. In many ways, this is (yet another) 100-year storm for financial markets but, unlike in the past, there is not one focal point in the financial markets or economy. It is not banks; it is not S&Ls; it is not dot-com or energy or another Long-Term Capital Management. In that sense, what investors are currently experiencing is a very different form of market stress in that traditional bunkers in which to hide from risk are scarce.
Current markets are volatile and fast. The outlook is uncertain and unpleasant. As portfolio managers, we seek to balance the needs for capital preservation, liquidity, positioning portfolios to avoid future landmines and being able to take advantage of liquidation-driven opportunities in order to add alpha to our portfolios. Over the course of the turmoil, we believe we have achieved these goals.
First-Quarter 2020 Performance Highlights
- Heading into “coronacrisis,” our portfolios were defensively positioned from both a duration and credit standpoint. Why? A key tenet of our philosophy: take risk only when compensated appropriately. Prior to the sell-off, spreads were tight and yields were low. Overall market leverage was building, especially in corporates. We spent most of 2018 and 2019 in risk-off mode, waiting for better buying opportunities. These opportunities have certainly arrived, and while we expect some volatility across our recent purchases in corporate credit and securitized holdings, we are quite confident in our ability to navigate choppy waters ahead.
- Over the quarter, many participants were forced to be price-takers. The need for liquidity came at a high cost to those bondholders who were looking to raise cash either out of safety or to meet redemptions. We have been the beneficiaries of net inflow, as well as having actively moved our portfolios into shorter duration, highly liquid securities over the last year, such that we can be providers of liquidity on very attractive terms.
- During the first quarter, the Thornburg Limited Term Income Fund (I shares) returned negative 0.68%, underperforming the longer duration Bloomberg Barclays Intermediate Government/Credit Index which returned of 2.40%. We remain confident in our thoughtful, yet nimble and opportunistic process during times of market stress; if the last financial crisis is any guide, our strategy should be well suited to provide investors attractive returns on a go-forward basis.
Current Positioning and Outlook
Despite an investment-grade-only mandate, our opportunity set is broad, spanning corporate credit, municipal debt and securitized products (e.g. agency and non-agency RMBS and CMBS, Consumer and other forms of ABS), and of course “risk-free” assets such as Treasuries. Through our process we seek to assess fundamental opportunities relative to compensation and for most of the last 18 months, compensation was subdued at best. This quickly changed as economic realities from the spread of the COVID-19 virus and secondary effects (e.g. oil market collapsing) reverberated through markets.
Despite the media attention on the trouble in the corporate bond market, it was ABS and non-agency MBS that inflicted the most pain on investors. Why? Short-durations within the securitized arena attracted forced sellers who believed any price declines from spread widening would be minimal. Unfortunately, they were mistaken. Also, investors had flocked to this area for a pickup in yield relative to corporate bonds as ABS and non-agency MBS securities were “cheap for the rating,” which, please note, happens to be one of the most dangerous sayings in our business. But as the perception of credit risk increased, investors rushed for the exits at once, creating further liquidity issues. As this ensued, we were able to be the liquidity provider in the marketplace and pick up attractive securities at discounted prices across the securitized landscape.
Of course, the corporate bond market was not spared. In fact, the degree of spread widening across the market was both significant and more rapid than in prior bear markets. And while we shared concerns about the unknown impact of the virus on the global economy and the investment-grade-credit universe, we did believe that spreads in the higher-quality portion of the market began to reflect a significant amount of pain. In the final month of the quarter, we began to buy corporate credit at attractive spreads relative to recent history.
The opportunities first began to appear in the secondary market, but as the primary market reopened, we sought to capture new issue concessions which first appeared in the 50–100 basis point (bps) range and broadly performed well. Most recently these concessions have dropped down to the 0–20bps range amid monetary and fiscal support for investment grade corporations. In Thornburg Limited Term Income, we began the quarter with ~35% in corporate bonds. By the end of March, we had opportunistically increased that exposure to ~42% while avoiding some of the most COVID-19-exposed business models. In fast-moving environments, managers must be nimble to succeed.
Going forward, we continue to believe we’ll see additional volatility in markets as we’ve only just begun to see negative economic data. A plethora of governmental actions within the market will certainly dampen negative effects, but we continue to sail in uncharted waters. This means we’ll likely see further sell-offs that will yield additional opportunities where we can nimbly take advantage. Our strategies were well prepared going into this current crisis and stand to be on even better footing coming out.
Performance data shown represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate so shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than quoted. For performance current to the most recent month end, see the mutual funds performance page or call 877-215-1330. The maximum sales charge for the Fund’s A shares is 1.50%.