3rd Quarter 2011 Commentary - ASTON/TCH Fixed Income Fund
3rd Quarter 2011
The Fund underperformed its Barclays Capital US Aggregate Bond Index benchmark during the quarter, in what proved to be the index’s strongest performance since the fourth quarter of 2008. Relative returns lagged mainly owing to a sizeable underweight to US Treasury Bonds (and a corresponding overweight to Corporate bonds) as investors generally sought safety given concerns about the financial stability of Europe and the turmoil in equity markets. Despite a new record low yield in the 10-year Treasury, long-term Treasuries outperformed intermediate Treasuries by more than 21 percentage points as long Treasuries posted their best quarterly returns ever. Corporate bonds trailed duration-matched Treasuries by nearly 5 percentage points.
Within Corporate bonds, the portfolio’s overweight to lower-quality investment grade securities also detracted from returns. AAA-rated securities outperformed AA-, A-, and BBB-rated securities by several percentage points in-line with the overall flight-to-quality by investors during the quarter. In addition, a stake in floating-rate notes, which underperformed fixed-rate notes, also detracted from relative performance as rates declined.
The Fund benefitted from its barbell portfolio structure as the yield curve shifted in a bull flattening fashion following the announcement of Operation Twist by the Federal Reserve. Operation Twist is the Fed’s plan to extend the average maturity of securities it holds by purchasing $400 billion of longer-term Treasuries (maturities of six to 30 years) and selling an equal amount of short-term securities (remaining maturities of three years or less). This, along with greater support for mortgage-backed securities, is intended to drive long-term borrowing rates lower, thereby encouraging businesses and households to further term-out their liabilities. This is an unprecedented undertaking, in our view, and will result in a flattening of the historically steep yield curve. Thus, the portfolio remains structured in a barbell fashion in anticipation that yield curves will continue to flatten going forward.
Heading into the final quarter of 2011, both equity and debt markets remain in a state of flux. Investors saw an increase in volatility throughout financial markets during the third quarter, as renewed concerns surrounding the health of European banking institutions, the solvency of Eurozone countries, and the continued discourse over the U.S. fiscal and monetary policies accelerated. Although U.S. economic growth increased during the second quarter at a clip slightly better than consensus estimates, economic activity remains anemic. Elsewhere, the Fed cited, “strains in the global financial markets” and stubbornly high unemployment as “significant downside risks to the economy.”
As a result of the weakening economic outlook the Fed kept its targeted range for the Fed funds rate at 0.0% to 0.25%, citing economic conditions likely to warrant exceptionally low levels through mid-2013. Although, the Fed expects commodity-price driven inflation to “dissipate further”, the language did express concern that inflationary pressure may prove higher than anticipated. Philadelphia Fed President Charles Plosser, one of three dissenting votes, cited ongoing fiscal and structural economic concerns as challenges inhibiting the effectiveness of new monetary policy actions and warned against “creating an environment of stagflation, reminiscent of the 1970s.”
Taplin, Canida & Habacht (TCH)
Note: Bond funds are subject to interest rate and credit risk similar to individual bonds. As interest rates rise or credit quality suffers, an investor is susceptible to loss of principal.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.