1st Quarter 2011 Commentary
The Fed Holds
In its semi-annual Monetary Policy Report to the Congress released March 1, 2011, the Federal Reserve noted that the “strong tenor of the recent information, along with the additional fiscal stimulus… (suggested) that the recovery had gained some strength—a development seen as likely to carry into 2011—and that the expansion was on firmer footing.” The Fed, however, noted tight credit conditions, weakness in residential construction, and fiscal strains on the budgets of local, state and the federal governments as headwinds that will moderate growth. Global shocks such as the geopolitical unrest in the Middle East, worsening fiscal conditions in peripheral Europe, and the aftermath of the earthquake, tsunami and partial nuclear meltdown in Japan threaten the recovery as energy prices move higher and supply constraints hinder production at the same time that inventories remain lean. As a result, following its March 15 meeting, the Fed kept its targeted range for the fed funds rate between 0% and .25%, the same level since 2008.
In response to unrest in the Middle East, oil prices have moved to the highest level since September 2008. Commodity prices have risen in response to the global economic recovery, posing heightened inflationary risks over time. The Journal of Commerce Industrial Commodity Price Index reached the highest month-end level on record, implying rising producer prices over time. In February, producer prices accelerated at their fastest pace since June 2009.
Corporates Continue to Lead
The Fund outperformed its Barclays Capital US Aggregate Bond Index benchmark during the quarter. The portfolio's large overweight stake in Corporate bonds boosted returns as the best performing sector on an absolute and duration-adjusted basis. Intermediate-term Corporates outperformed longer maturity Corporates as the effect of rising interest-rates was more pronounced on the long end of the curve. US Treasuries realized negative returns as the yield curve shifted in a bear flattening fashion. An overweight position in mortgage-backed securities helped as well, as that group outperformed duration-matched Treasuries by 55 basis points.
Financials were the best performing credit subsector on an absolute and duration-adjusted basis during the quarter, outperforming Industrials and Utilities—the next biggest increases. Lower-quality, investment-grade securities were the best performing quality bucket as BBB-rated issues outperformed A-, AA-, and AAA-rated securities by 15, 66 and 37 basis points, respectively.
As the economy recovers, the unprecedented government interventions implemented during the financial crisis continue to be unwound. On March 21, the U.S. Treasury announced its intentions to sell the mortgage-backed securities originally purchased under the Housing and Economic Recovery Act of 2008 (HERA). We believe these sales represent an important milestone and may be a harbinger of asset sales by the Federal Reserve. The second round of quantitative easing is scheduled to end on June 30, 2011, and Fed officials have indicated that further easing is unlikely. A passive move to tighter monetary policy will likely begin this year.
In our view, government interventions have played a significant role in steepening the yield curve for Treasury bonds and we anticipate that the unwinding of quantitative easing will flatten the curve over time. While the Treasury yield curve reflects an accommodative Fed policy and expectations for a sustainable economic recovery, Corporate bond spread curves also remain steep. We believe the steepness in Corporate curves is atypical at this point in the economic cycle and represents an attractive opportunity. Specifically, the Fund is maintaining a bar-belled portfolio structure in anticipation that spread curves will flatten over time.
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.