| Performance As of March 31, 2024 |
||||||
|---|---|---|---|---|---|---|
|
Total Return |
Average Annual Total Returns |
||||
Composite/Benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
Since Inception |
BBH Multisector Fixed Income Composite (Gross of Fees) |
3.02% |
3.02% |
13.76% |
4.99% |
5.57% |
4.66% |
BBH Multisector Fixed Income Composite (Net of Fees) |
2.91% |
2.91% |
13.31% |
4.58% |
5.15% |
4.25% |
Bloomberg US Aggregate Bond Index |
-0.78% |
-0.78% |
1.70% |
-2.46% |
0.36% |
1.37% |
| Past performance does not guarantee future results Returns of less than one year are not annualized BBH Multisector Fixed Income Composite inception date is 06/01/2014 |
||||||
| Bloomberg US Aggregate Bond Index is comprised of U.S. dollar-denominated investment grade fixed income securities with maturities of at least one year. The index includes corporate, government, and mortgage-backed securities. One cannot invest directly in an index. Sources: Bloomberg and BBH & Co. |
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1Q Highlights
|
Market Environment
Treasury rates continued to be volatile as strong economic data and stubbornly high inflation data drove market sentiment back towards a “higher for longer in 2024” disposition, although the yield curve still had three 25 basis point.1 Federal Reserve (Fed) interest rate cuts priced in by the end of this year. Shorter-duration fixed income indexes generated positive returns during the first quarter while longer-duration indexes experienced negative total returns. Excess returns to credit were posi¬tive across sectors, with agency mortgage-backed securities (MBS) being the notable exception that underperformed comparable duration Treasuries as the Fed continued shrinking its balance sheet.
Economic data has remained strong as inflationary pressures persist and there are few signs of recession on the horizon. Headline consumer inflation prints have been stronger than anticipated, and wage growth remains higher than historic averages. The Chicago Fed National Activ¬ity Index remains above its recession indicator threshold. Default rates of below investment-grade companies also remain subdued despite higher interest rates. The U.S. consumer appears to be on solid footing, with loan delinquency rates generally rising off very low bases and not indicating widespread issues. Although auto loan delinquency rates have risen to their highest levels since 2009, and defaults for subprime auto loans have increased above their pre-COVID-19 levels, these data points are within expected ranges for losses in asset-backed securities (ABS) and do not currently pose risk of impairment to bondholders. Delinquency rates on business loans held at U.S. commercial banks remain near cyclical lows. Commercial real estate loan delinquency rates at U.S. banks continue to creep higher, which parallels the rising delinquency rates being experi¬enced in commercial mortgage-backed securities (CMBS) related to office properties.
Exhibit I: Fixed income index returns for various indexes as of March 31, 2024, displaying duration, total return, and excess return.
Valuations
Credit spreads narrowed across sectors and qualities despite the deluge of issuance during the quarter. This highlights both the intense demand for credit and the increasing complacency of investors evaluating new issues. The average option-adjusted spread (OAS) of the Bloomberg U.S. Corporate Index was 90 basis points at the end of the period, which was the lowest level since December 2021. When the Index’s spread is less than 100 basis points, the Index tends to underperform Treasury alternatives moving forward.
As a result of the tighter credit spread environment, we are finding fewer opportunities in traditional segments of the credit markets. According to our Valuation Framework,2 the percentage of investment-grade corporate bonds that screened as a “Buy” decreased to 13% versus 23% at the start of the quarter and 47% at the end of the first quarter last year, with the prospects for longer-duration bonds looking particularly unattractive. The percentage of high-yield corporate bonds that screened as a “Buy” in our Valua¬tion Framework declined to 16% from 24% at the start of the quarter and 47% at the end of the first quarter last year, with “Buy” candi¬dates having become sparse in the double-B benchmark. No cohort of 30-year or 15-year agency MBS met our Valuation Framework criteria for new purchases at quarter-end.
However, there does remain opportunities in select subsectors of the market. Senior bank loans continue to screen attractively, with 87% of the universe screening as a “Buy” candidate. We continue to find opportunities in investment-grade bonds issued by life insurers and banks. Several “BB” and “B” rated bonds issued by specialty financial companies, banks, and real estate investment trusts (REITs) screen attractively in the high yield bond universe. In the structured credit markets, opportunities remain despite the recent narrowing of credit spreads, with spreads in some select sectors remaining disconnected from their underlying credit risk. Opportunities are also arising in the CMBS market as investors differentiate between office properties and other prop¬erty types with solid credit dynamics. We continue to avoid non-agency residential mortgage-backed securities (RMBS) due to poor technical factors, and weak fundamentals, underpinned by poor housing affordability, low inventory of homes for sale, and stable-to-declining home prices.
Exhibit II: Market outlook by sector as of March 31, 2024, broken-down by reserves, structured credit, corporate credit, and other credit categories.
Performance
The portfolio’s sector and rating emphases drove results during the quarter. The portfolio was overweight to several strong-performing segments of the credit markets, including CMBS, senior bank loans, investment-grade corporate bonds, ABS, and high yield corporate bonds.
The portfolio’s duration profile contributed to performance during the quarter as short-term interest rates maintained positive total returns despite a general increase in interest rates.
Security selection enhanced performance results, and contributions were diversified across sectors. Holdings of investment-grade corporate bonds issued by property and casualty (P&C) insurers, life insurers, specialty finance companies, and banks contributed to results, as did positions in securi¬tizations of collateralized fund obligations, aircraft equipment leases, and recurring revenue loans and senior bank loans to electric utilities. Selection results in CMBS hindered results during the quarter, as did positions in high yield credits (senior bank loans and/or bonds) issued by technology companies, midstream energy companies, and pharmaceuticals.
Exhibit III: Attribution as of March 31, 2024, showing average portfolio weight and gross contribution displayed in basis points.
Transaction Summary
We continued to find durable credits3 offering attractive value despite dwindling attractiveness of valuations of credits in Indexes. The purchases were made across a variety of sectors and industries. Descriptions of a few notable portfolio additions are included below.
Longtime holding SiriusPoint Ltd is a reinsurance company with a strong and stable European business and a strong capital structure that includes subordinated bonds, safety reserves, and a large equity cushion. We purchased their new issue, 5-year, BBB- rated bonds at a spread of 288 basis points over Treasuries for a yield of 7.1%. We found appeal in several issuances from business development companies (BDCs) that possessed strong management, exceptional credit performance history, and the conservative leverage profile common among BDCs, including Owl Rock’s Blue Rock Technology Finance Corp II (5-year, BBB rated bonds at a spread of 283 basis points over Treasuries for a yield of 7.0%), venture debt lender Trinity Capital (5-year, BBB- rated preferreds at a spread of 365 basis points over Treasuries for a yield of 7.9%), and Main Street Capital (5-year, BBB- rated bonds at a spread of 300 basis points over Treasuries for a yield of 7.0%).
We purchased a position in the residual tranche of a small business loan securitization, BHG 2023-B, brought by Bankers Healthcare Group (BHG). BHG is a specialty finance company providing commercial and consumer financing to high income, skilled professionals in proven healthcare practices. The securitization features large excess spreads and substantial early payments, and we estimate the position to have an attractive absolute return profile with a short weighted average life, while we believe the structure affords a loss cushion to a range of performance and economic scenarios. FREMF 2024-K516 is a 2024 new-issue five-year fixed rate Freddie Mac agency CMBS transaction, secured by a pool of 24 first mortgage loans. The properties represented are 97% multifamily and 3% manufactured housing community assets, and the occupancy rate was 94.0%. BBH was active in credit due diligence of the deal, including reviews of third-party appraisal, environmental, and engineering reports, Freddie Mac underwriting loan tapes, rating agency presale reports, on-site visits to all collateral properties, and underwriting the individual loans in the pool. We purchased a posi¬tion in the junior, non-guaranteed class C notes at a forecasted spread of 475 basis points over Treasuries for an estimated yield of 9.3%. OXFINF 2024-A is a venture debt securitization brought by Oxford Venture Finance, a specialty finance company focusing on lending to early and middle stage life sciences companies. The company has had less than 1% of cumulative net charge-offs since 2002. The bonds boast considerable credit support rising from overcollateralization. We purchased the BBB rated bonds at a spread of 355 basis points over Treasuries for a yield of 7.7%.
In the high yield market, leading global mobile satellite services provider Inmarsat came to market during the quarter with a term loan. The company possesses significant asset value in its unique network for its satellite constellation and large installed base on ships and airplanes, and its equipment is critical infrastructure installed in most oceanic ships and commercial airline cockpits. We purchased the BB+ rated senior bank loans at a spread of 350 basis points over Secured Overnight Financing Rate (SOFR)4 for a yield of 8.8%. We also participated in the refinancing of United Airline’s senior bank loan secured by the company’s landing and take-off slots, routes, and gates. The BB+ term loan was purchased at a spread of 284 basis points over SOFR for a yield of 8.2%. We added to our position in senior bank loans of MultiPlan, the largest network provider of out-of-network claim services with a long operating history, a track record of consistent cash flow generation and deleveraging, and a sticky and hard-to-replicate service offering. We purchased the B+ rated term loans at a spread of 524 basis points over SOFR for a yield of 10.6%. We also added to our position in bonds issued by Bread Financial Holdings, a publicly traded provider of loyalty and affinity credit card solutions with significant cash flow for debt servicing and demonstrated resiliency during COVID-19. We purchased the BB- rated bonds at a spread of 524 basis points over Treasuries for a yield of 9.5%.
Characteristics
At the end of the quarter, the portfolio’s duration was 2.1 years and remained near levels consistent with long-term capital preservation. The portfolio’s holdings of reserves increased to 10% from 1% last quarter, reflecting the decreasing number of attractive credits in the market. Weights to all other credit sectors decreased, except for the weight to senior bank loans that were little changed. The portfolio’s allocation to high yield and non-rated instruments declined slightly to 48%. The portfolio’s yield to maturity was 9.1% and remained elevated versus bond market alternatives. The portfolio’s option-adjusted spread was 416 basis points; for reference, the Bloomberg U.S. Corporate Index’s option-adjusted spread was 90 basis points, and the Bloomberg U.S. Corporate High Yield Index’s option-adjusted spread was 299 basis points at quarter-end.
Exhibit IV: Characteristics as of March 31, 2024, including credit rating and sector allocation for both the portfolio and benchmark.
Concluding Remarks
We believe credit and valuation discipline remain essential as others may be tempted to reach for yield with still-elevated interest rates. With robust issuance, eager investor demand, and narrow credit spreads, it is imperative that each opportunity be carefully vetted for durability and meet our required valuation criteria prior to investment. The most worrisome risks are often those that are unanticipated. Therefore, we continue to evaluate each credit’s durability, structure, management, and transparency while stress-testing the credit to the worst environment its industry faced before investing. We believe preparation and discipline will be necessary for navigating the months and quarters ahead.
1 Basis point (bps) is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
2 Our valuation framework is a purely quantitative screen for bonds that may offer excess return potential, primarily from mean reversion in spreads. When the potential excess return is above a specific hurdle rate, we label them “Buys” (others are “Holds” or “Sells”). These ratings are category names, not recommendations, as the valuation framework includes no credit research, a vital second step.
3 Obligations such as bonds, notes, loans, leases, and other forms of indebtedness, except for cash and cash equivalents, issued by obligors other than the U.S. Government and its agencies, totaled at the level of the ultimate obligor or guarantor of the Obligation. Durable means the ability to withstand a wide variety of economic conditions.
4 Free cash flow (FCF) is the cash a company generates after taking into consideration cash outflows that support its operations and maintain its capital assets.
The securities do not represent all of the securities purchased, sold, or recommended for advisory clients and you should not assume that investments in the securities were or will be profitable.
Issuers with credit ratings of AA or better are considered to be of high credit quality, with little risk of issuer failure. Issuers with credit ratings of BBB or better are considered to be of good credit quality, with adequate capacity to meet financial commitments. Issuers with credit ratings below BBB are considered speculative in nature and are vulnerable to the possibility of issuer failure or business interruption.
Purchase and sale information provided should not be considered as a recommendation to purchase or sell a particular security and that there is no assurance, as of the date of publication, that the securities purchased remain in a portfolio or that securities sold have not been repurchased.
Opinions, forecasts, and discussions about investment strategies are as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are not intended to be and should not be interpreted as recommendations.
Definitions
The Bloomberg US Aggregate Bond Index is a market-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $300 million par amount outstanding and with at least one year to final maturity.
Duration is a measure of the portfolio’s return sensitivity to changes in interest rates.
An index is not available for direct investment.
“Bloomberg®” and the Bloomberg indexes are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indexes (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the Strategy. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the Strategy.
RISKS
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, maturity, call and inflation risk; investments may be worth more or less than the original cost when redeemed. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Mortgage-backed securities have prepayment, extension, and interest rate risks.
Asset-Backed Securities ("ABS") are subject to risks due to defaults by the borrowers; failure of the issuer or servicer to perform; the variability in cash flows due to amortization or acceleration features; changes in interest rates which may influence the prepayments of the underlying securities; misrepresentation of asset quality, value or inadequate controls over disbursements and receipts; and the ABS being structured in ways that give certain investors less credit risk protection than others. Below investment grade bonds, commonly known as junk bonds, are subject to a high level of credit and market risks.
The Strategy invests in derivative instruments, investments whose values depend on the performance of the underlying security, assets, interest rate, index or currency and entail potentially higher volatility and risk of loss compared to traditional bond investments.
Foreign investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.
The Strategy may engage in certain investment activities that involve the use of leverage, which may magnify losses.
A significant investment of assets in one or more sectors, industries, securities and/or durations may increase its vulnerability to any single economic, political, or regulatory developments, which will have a greater impact on returns.
Illiquid investments subject the investor to the risk that she may not be able to sell the investments when desired or at favorable prices.
Portfolio Characteristics are of the Representative Account. The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the Strategy.
Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact John W. Ackler at 212 493-8247 or via email at john.ackler@bbh.com.
Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. Net of fees performance results reflects the deduction of the maximum investment advisory fees. Returns include all dividends and interest, other income, realized and unrealized gain, are net of all brokerage commissions, execution costs, and without provision for federal or state income taxes. Results will vary among client accounts. Performance calculated in U.S. dollars.
The objective of our Multisector Fixed Income Strategy is to deliver excellent returns in excess of industry benchmarks through market cycles. The Composite includes all fully discretionary fee-paying with an initial investment equal to or greater than $10 million that are managed using the Multisector Fixed Income Strategy. Accounts are invested in a broad range of taxable bonds, with the duration target approximately 4.5 years. Investments are primarily investment grade securities. Account guidelines are not materially restrictive. Account that subsequently fall below $9.25 million are excluded from the Composite.
Brown Brothers Harriman & Co. (“BBH”) may be used to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2024. All rights reserved.
Not FDIC Insured No Bank Guarantee May Lose Money
IM-14655-2024-05-06 Exp. Date 07/31/2024
