4th Quarter 2011
Uncertainty surrounding the health of European governments and financial institutions caused substantial volatility and weighed heavily on global financial markets in 2011. The month of December was no exception as investors continued to digest headlines, notably Standard & Poor’s (S&P) placing the long-term sovereign credit ratings of 15 countries within the European Monetary Union (EMU) on CreditWatch due to systematic stresses in the Eurozone.
Following the conclusion of its December meeting, the Federal Reserve stated that recent data suggests the U.S. economy had been expanding moderately though with some apparent slowing in global growth. The Fed did acknowledge that the unemployment rate remained elevated despite improvement in the conditions of the overall labor market. Moreover, it expected strains in financial markets to pose significant downside risk to the U.S. economic outlook, and thus was continuing its program to extend the average maturity of its holdings of securities as announced in September.
Throughout 2011, the Federal Reserve communicated its expectations for the U.S. economy with a fragile tone before finishing the year with a cohesive stance towards current monetary policy. In our view, it is unlikely that the Fed will move from accommodative policy during 2012, absent a significant decline in unemployment or a material change in long-term inflation expectations. Therefore, we do not foresee a change to the exceptionally low Federal Funds rate that the Fed has targeted through the middle of 2013.
The Fund outperformed its Barclays Capital US Aggregate Bond Index benchmark during the quarter as sector, credit-quality, and yield-curve selection all added value. The portfolio’s above-market exposure to the outperforming credit sector aided returns, with Corporate bonds besting duration matched Treasuries as spreads tightened modestly. Within credit itself, an overweight to lower-quality investment-grade securities helped as BBB-rated credit securities outperformed A-, AA-, and AAA-rated bonds by healthy margins.
A barbell portfolio structure also boosted returns as rates declined across the yield curve during the fourth quarter. In this environment, longer-dated securities outperformed with long-term US Treasuries outperforming intermediate Treasuries. All told, long Treasuries outperformed intermediate Treasuries by more than 23 percentage points during the full year, the largest margin on record.
In 2011, investors dealt with the European uncertainty and persistent bouts of volatility with a flight to quality. In such a “risk-on/risk-off” environment, corporate bond spreads widened regardless of the issuer’s direct exposure to Europe, if any, as investors considered a potential disconnect between the domestic economy and those abroad. Although the global nature of the European crisis cannot be overlooked, a significant portion of U.S. corporations carry little direct exposure to Europe, and an even greater number have been scaling back investment in Europe since before the crisis emerged. In our view, the outcome for U.S. corporate bonds is more contingent on the domestic economy and the degree to which sound financial discipline has allowed issuers to utilize the low interest-rate environment to improve their balance sheets. On a relative basis, corporate bonds issued by entities that have termed out liabilities, demonstrably reduced their debt burden, and continue to produce strong cash flow throughout the business cycle remain attractive.
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.