| Performance As of December 31, 2023 |
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|---|---|---|---|---|---|---|---|
|
Total Returns |
Average Annual Total Returns |
|||||
Composite/Benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
10 Yr. | Since Inception |
BBH Core Plus Fixed Income Composite (Gross of Fees) |
7.54% |
9.51% |
9.51% |
-0.89% |
3.61% |
4.12% | 6.32% |
BBH Core Plus Fixed Income Composite (Net of Fees) |
7.47% |
9.24% |
9.24% |
-1.13% |
3.35% |
3.87% | 6.05% |
Bloomberg US Aggregate Bond Index |
6.82% |
5.53% |
5.53% |
-3.31% |
1.11% |
1.81% | 5.61% |
| Past performance is no guarantee of future results Strategy Inception: 01/01/1986 Returns of less than one year are not annualized |
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| The 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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4Q Highlights
|
Market Environment
Interest rates fell and credit spreads narrowed across the fixed income markets during the fourth quarter. Just three months ago, the Bloomberg Aggregate Index (the “Index”) had a negative year-to-date total return after interest rates rose and market conditions suggested a “higher-for-longer” interest rate environment. Those conditions changed rapidly, as investor expectations now reveal quicker and larger Federal Reserve (Fed) rate cuts in 2024. The prospect of near-term Fed easing may also alleviate investor concerns about near-term economic risks.
Fixed income indexes experienced positive returns amid the decline in interest rates (see Exhibit I). Risk spreads narrowed significantly throughout the credit markets and provided an additional boost to the performance of credit indexes. Indexes of investment-grade (IG) corporate bonds, asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), high yield (HY) corporate bonds, senior bank loans, and collateralized loan obligation (CLO) debt all outperformed Treasury alternatives during the quarter. The Agency MBS Index also posted notably strong performance after exhibiting volatility throughout the year as the Fed executes its quantitative tightening campaign.
Exhibit I: Fixed income index returns for various indexes as of December 31, 2023, displaying duration, total return, and excess return.
Year-to-date, all credit indexes had positive excess returns. Non-agency CMBS outperformed comparable duration Treasuries slightly despite negative headlines regarding commercial real estate. Indexes of IG corporate bonds, senior bank loans, HY corporate bonds, nontraditional ABS, and CLO debt posted strong excess returns.
Valuations
Narrowing risk spreads caused valuations to weaken during the quarter. According to our valuation framework,1 the percentage of IG corporate bonds that screened as a “buy” decreased to 23% versus 32% at the start of the quarter, while the percentage for HY corporate bonds was 24% versus 33% at the start of the quarter. Senior bank loans continue to screen attractively, with over 90% of the universe screening as a “buy” candidate.
There remains an abundance of opportunities in select subsectors of the market (see Exhibit II). We continue to find opportunities in intermediate maturity bonds and IG bonds issued by companies operating in interest rate sensitive sectors, like banks, life insurance, and real estate investment trusts (REITs). Several double-B and single-B rated bonds issued by companies in the wireline, wireless, transportation services, and media-entertainment sectors screen attractively. In the structured credit markets, we observe a continuing disconnect between wider credit spread levels and solid credit performance. We are finding an abundance of attractively valued opportunities in non-traditional ABS issuances and CLO debt. We believe opportunities in the CMBS market will arise as stronger properties come to market with Single Asset, Single Borrower (SASB) securitizations that facilitate strong transparency.
Exhibit II: Market outlook by sector as of December 31, 2023, broken-down by reserves, structured credit, corporate credit, and other credit categories.
There are several sectors where valuation and durability concerns lead us to avoid positions in client portfolios. Valuations of agency MBS weakened amid strong spread compression during the fourth quarter, and only small segments of the market screen as a “buy” candidate to us. We continue to avoid non-agency residential mortgage-backed securities (RMBS) due to poor technical factors and weak fundamentals underpinned by weak housing affordability, low inventory of homes for sale, and stable-to-declining home prices. We continue to avoid emerging markets credits due to concerns regarding creditor rights in most countries.
Performance
Sector and rating emphases contributed to relative results during the quarter. The Strategy was overweight to several strong-performing segments of the credit markets, including senior bank loans, IG corporate bonds, HY corporate bonds, and ABS. The avoidance of agency MBS hindered relative results during the quarter.
Security selection detracted from relative performance, although results were mixed across sectors. Holdings of IG corporate bonds issued by electric utilities, property and casualty (P&C) insurers, and business development companies (BDCs) impacted results negatively. Positions in senior bank loans detracted in aggregate, although holdings of loans to electric utility companies had a notable positive impact on selection results. Positive selection results were experienced in holdings of HY corporate bonds.
The duration and yield curve profile contributed to results during the quarter. Agency MBS was not owned in the Strategy but carries a significant weight in the Index. Agency MBS has negative convexity, and its duration can change day-to-day with changes in interest rates and interest rate volatility. We manage the portfolio’s duration to replicate the Index’s as transactions occur – not to changes in the Index’s day-to-day duration swings – and this contributed as the Strategy’s duration did not decline while the Index’s duration did during an episode of declining interest rates.
Exhibit III: Attribution as of December 31, 2023, showing average portfolio weight and gross contribution displayed in basis points.
| Representative Account Performance (Net of Fees) | |||
|---|---|---|---|
|
Portfolio |
Benchmark |
Active |
Fourth Quarter |
7.29% |
6.82% |
0.47% |
1 Year |
9.08% |
5.53% |
3.55% |
5 Year |
3.11% |
1.10% |
2.01% |
Since Inception |
3.07% |
1.29% |
1.78% |
Past performance is no guarantee of future results Representative Account Inception Date: 12/03/2002 |
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Transaction Summary
We continued to find durable credits2 offering attractive value despite dwindling attractiveness of valuations of credits in Indexes. Purchases were made across a variety of sectors and industries. Descriptions of a few notable portfolio additions are included below.
Macy’s is a large U.S. department store chain company that boasts improving operational performance, low leverage, good liquidity, and no near-term debt maturities. We purchased the 2030 maturity, BBB- rated bonds in the secondary market at a spread of 478 basis points3 over Treasuries for a yield of 9.7%. IQVIA is a global provider of advanced analytics, technology solutions, and clinical research services to the life sciences industry. The company boasts a leading market position within a favorable environment for end-market clients, a high percentage of recurring revenues and visibility, low and declining leverage, strong free cash flow4 (FCF) generation, and an experienced and well-regarded management team. We purchased the new issue BBB- rated term loan at a spread of 200 basis points over SOFR5 for a yield of 7.4%.
FREMF 2023-K753 is a 2023 new-issue seven-year fixed rate $964.3 million Freddie Mac agency CMBS transaction, secured by a pool of 32 first mortgage loans across 37 properties. The properties represented are 95% multifamily and 5% senior housing facilities and manufactured housing community assets, and the occupancy rate was 95.1%. 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 positions from the deal in interest-only bonds at a spread of 447 basis points over Treasuries and in junior non-guaranteed notes.
SIDC 2023-3A is a data center ABS deal brought by repeat issuer Stack Infrastructure Issuer LLC. The ABS is secured by revenues from 10 data centers located in top U.S. markets with larger market cap customers with long-term take or pay contracts. The bonds are supported by robust credit support and structural protections. We purchased the 5-year weighted average life, A- rated bonds at a spread of 245 basis points over Treasuries for a yield of 5.9%.
In the HY market, ams AG came to market during the quarter. The Austrian company is the third largest sensor and photonics provider in the world behind Sony and Samsung. The company recently lowered its debt load, has a solid liquidity profile, is cushioned by a $1.0 billion equity market capitalization, and has a path to decrease leverage in 2024. We purchased the new issue 5-year, BB- rated bonds at a spread of 803 basis points over Treasuries for a yield of 12.5%. Credit Acceptance Corp provides funding, receivables management, collection, sales training, and related services to automobile dealers. The company has a proven track record in underwriting lower tier subprime borrowers, their strength is accurately forecasting collection rates on loans, and losses have been negligible because it advances, on average, only 45% of the gross amount of the installment sales contract to dealers. We purchased the new issue 5-year, BB rated bonds at a spread of 499 basis points over Treasuries for a yield of 9.3%. Bread Financial Holdings is a publicly traded provider of loyalty and affinity credit card solutions. The company has a strong position in its industry, produces significant cash flow for debt servicing, and demonstrated resiliency during COVID-19. We purchased the new issue 5-year, BB- rated bonds at a spread of 548 basis points over Treasuries for a yield of 9.8%.
Characteristics
At the end of the quarter, the Strategy’s duration was 6.2 years and continued to approximate that of its benchmark (see Exhibit IV). Holdings of Treasuries and reserves increased to 14% from 10% amid weakening credit valuations. Allocation to HY instruments remained near 17%. Yield to maturity was 6.5% and remained elevated versus bond market alternatives. The option-adjusted spread (OAS) was 245 basis points; for reference, the Bloomberg U.S. Corporate Index’s OAS was 99 basis points at quarter-end.
Exhibit IV: Characteristics as of December 31, 2023, including credit rating and sector allocation for both the portfolio and benchmark.
Conclusion
Several forces are being exerted on credit markets in 2024, and the effect on credit spreads and transaction volumes is uncertain. Valuations, potential defaults and recession, the prospect of Fed easing, heightened refinancing needs, and fund flows in a higher Treasury rate environment can cause the market to behave erratically in any given year, and this year promises to be no different. That is why strong valuation and credit disciplines are imperative to performing in the market.
1 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.
2 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.
3 Basis points (bps) is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
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.
5 SOFR = Secured Overnight Financing Rate, which is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.
Totals may not sum due to rounding.
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
Bloomberg US Aggregate Bond Index is a market value-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 paramount outstanding and with at least one year to final maturity The index is not available for direct investment.
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
Investors should be able to withstand short-term fluctuations in fixed income markets in return for potentially higher returns over the long term. The value of portfolios changes every day and can be affected by changes in interest rates, general market conditions, and other political, social, and economic developments.
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.
SASB lacks the diversification of a transaction backed by multiple loans since performance is concentrated in one commercial property. SASBs may be less liquid in the secondary market than loans backed by multiple commercial properties.
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.
One basis point or bp is 1/100th of a percent (0.01% or 0.0001).
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 Core Plus Fixed Income Strategy is to deliver excellent after-tax returns in excess of industry benchmarks through market cycles. The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the strategy. The Composite included all fully discretionary, fee-paying core fixed income accounts over $10 million that are managed to a duration of approximately 4.5 years and are invested in a broad range of taxable bonds. Accounts 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-14140-2024-02-01 Exp. Date 04/31/2024
