RISR Commentary for September 2023
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The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, June be worth more or less than their original cost and current performance June be lower or higher than the performance quoted. Performance current to the most recent month-end can be obtained by calling 866-497-4963. Short term performance, in particular, is not a good indication of the fund’s future performance, and an investment should not be made based solely on returns. Returns beyond 1 year are annualized.
A fund's NAV is the sum of all its assets less any liabilities, divided by the number of shares outstanding. The market price is the most recent price at which the fund was traded. The fund intends to pay out income, if any, monthly. There is no guarantee these distributions will be made.
Total Expense Ratio is 0.99%.
For standardized performance click here.
Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 1.64% based on the closing market price (1.81% based on net asset value or “NAV”) in September. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inversed Index) returned 3.18% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned -2.54% during the same period.
The relentless rise in interest rates that resumed last April accelerated in September, with the 10-year jumping more than 46 bps, the sharpest monthly increase since September of the prior year. This further drove up mortgage rates, with the 30-year fixed rate national average closing the month at 7.31, the highest rate recorded since November of 2001.
It is worth noting that market rates have risen more than 150 bps since May against a backdrop of Fed Funds that have only been raised by 50 bps over the same period. The Fed has held its policy rate steady for most of its meetings since then. Nevertheless, market rates have risen persistently, which has closed the inversion between short-term and long-term rates substantially.
10-year Treasury Rate (GT10) vs Fed Funds Target Rate (FDTR)
In other words, The Fed has dramatically slowed the pace of rate hikes, but they have also made it clear that they intend to hold rates at these higher levels much longer than the market consensus view from mid-year 2023. As this realization has gradually settled in among market participants, market rates have priced in this reality with great certainty. There are now only a few lonely voices still predicting a pivot in Fed policy to begin cutting rates in the near term. This is a sharp contrast from only a few months ago, where many market participants were expressing views that directly contradicted the Fed’s expressly stated objectives to keep rates higher for longer, until inflation is fully and unambiguously back to its 2% target.
September also saw meaningful capital inflows. Total shares outstanding increased to 2.2 million in September, an increase of over 20% from a month earlier. It is difficult to say, who the incoming investors were, whether they were new to the Fund, or existing investors adding to their positions. In either case, it is beneficial to all investors to have a larger asset pool over which to spread expenses.
RISR vs 10-year Treasury Yield
As we have shown in prior commentaries, the chart above shows RISR tracking vs. the 10-year Treasury yield. By design, the tracking between the two has been close. Year-to-date 2023, the correlation between weekly changes in the 10-year and the price return of RISR has been about 67%. While there can be no guarantee we will be able to achieve such a high degree of tracking, we use the option-adjusted duration of our MBS interest-only securities to aim for that objective.
For technical reasons, as rates have continued to rise, it has become a bit more challenging to find securities with sufficient negative duration without also adding a small amount of additional negative convexity as well. We will keep a close watch on this. Any investors seeking additional information are encouraged to contact us for a more detailed conversation. In any case, we do not believe these technical factors will have a material effect on the overall utility of RISR as a highly useful hedge for investors broadly.
Outlook
One of the most over-used words in common parlance today is “narrative.” It can be useful, however, when thinking about markets during times of uncertainty to consider the prevailing narratives investors tell one another. For much of 2023, the prevailing narrative was that the Fed was aiming to create a “soft-landing,” for the economy. According to this narrative, rates would be increased only enough to slow economic growth and reduce inflationary pressures without actually causing a recession in which economic activity contracts, rather than simply experiencing slower positive growth. While it was difficult or even impossible to point to a historical precedent for the soft landing, it became the dominant market narrative for an extended period during 2023.
When it became clear that the labor markets were not cooperating, not slowing meaningfully, and were actually becoming tighter in certain respects, the narrative switched to something new. This new narrative was coined “no landing.” This meant that somehow, the Fed could pause its series of rate hikes, and begin the process of cutting rates, even though there would be no slowdown of economic activity, but that somehow inflation would steadily fall back to 2%. If the historical precedent for the soft-landing narrative was hard to discern, the no-landing narrative was utterly fanciful. Nevertheless, until very recently, this was a very widely held view.
It is now clear from the economic indicators that both these narratives were without foundation, and reflected what people hoped would happen rather than what historical precedent told them would likely actually happen.
Where things stand now, what is the current narrative, is unformed and unclear. There is no longer a discernable consensus for whether a recession is likely. Instead, there has been a general capitulation in favor of higher-for-longer interest rates, and away from any near-term shift to rate cuts from the Fed. But while the immediate rate outlook may have settled somewhat, what this means for inflation is far less clear.
Until a new narrative forms and takes widespread hold among market participants, it is our contention that the prudent posture for investors and managers is to take a conservative risk profile. This means reducing overall duration, holding investments, such as RISR, that can help modulate overall volatility, while still generating attractive current income. RISR currently pays a stabilized monthly dividend of $0.18/share. At the September closing price of $33.398, this represents a yield of 6.47%, which is roughly 4x the 1.62% yield of the S&P 500. (The 30-day SEC yield of RISR as of September 30, 2023 was 7.08%). The 30-Day SEC Yield is calculated with a standardized formula mandated by the SEC. The formula is based on the maximum offering price per share.
In sum, even if the Fed raises the Fed Funds rate only a bit more, or even if they don’t raise again this cycle, the trend for long-term yields continues to be upward, and volatility is likely to persist. We believe asset managers and advisors will have to keep a very sharp eye on the risk they are running. RISR has been specifically engineered to have broad appeal to a range of investors, who share with us a belief in the wisdom of prudently managing risk. RISR can help in that effort, offering a low correlation to many key market sectors, together with a high current dividend.
Please contact us to explore how RISR might fit into your overall strategy, to help you manage risk while generating an attractive current yield.
Portfolio Applications
We believe RISR provides an attractive, thematic strategy that provides strong correlation benefits for both fixed income and equity portfolios. It can be utilized as part of a core holding for diversified portfolios or as an overlay to manage the interest rate risk of fixed income portfolios. Alternatively, RISR can be used as a macro hedge against rising interest rates with less exposure to equity beta and negative correlation to fixed income beta. The underlying bonds are all U.S. agency credit that are guaranteed by FNMA, FHLMC or GNMA. There is no financing leverage or explicit short positions that relies on borrowed securities. Also, timing is on our side as the strategy generates current income if interest rates were to remain within a trading range.
Please contact us to explore how RISR can be utilized as a unique tool to adjust your portfolio allocations in the current inflationary environment.
| Yung Lim | Dean Smith | George Lucaci |
|---|---|---|
| Chief Executive Officer | Chief Strategist and Marketing Officer | Global Head of Distribution |
| Chief Investment Officer | RISR Portfolio Manager | |
| ylim@foliobeyond.com | dsmith@foliobeyond.com | glucaci@foliobeyond.com |
| 917-892-9075 | 914-523-2180 | 908-723-3372 |
This material must be preceded or accompanied by a prospectus. For a copy of the prospectus please click here.
Investments involve risk. Principal loss is possible. Unlike mutual funds, ETFs may trade at a premium or discount to their net asset value. The fund is new and has limited operating history to judge fund risks. The value of MBS IOs is more volatile than other types of mortgage related securities. They are very sensitive not only to declining interest rates, but also to the rate of prepayments. MBS IOs involve the risk that borrowers may default on their mortgage obligations or the guarantees underlying the mortgage-backed securities will default or otherwise fail and that, during periods of falling interest rates, mortgage-backed securities will be called or prepaid, which may result in the Fund having to reinvest proceeds in other investments at a lower interest rate.
The Fund’s derivative investments have risks, including the imperfect correlation between the value of such instruments and the underlying assets or index; the loss of principal, including the potential loss of amounts greater than the initial amount invested in the derivative instrument. The value of the Fund’s investments in fixed income securities (not including MBS IOs) will fluctuate with changes in interest rates. Typically, a rise in interest rates causes a decline in the value of fixed income securities owned indirectly by the Fund. Please see the prospectus for a complete description of principal risks.
Diversification does not eliminate the risk of experiencing investment losses.
Index Definitions
Bloomberg Barclays US Aggregate Bond Index: A broad-based benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
US Treasury 7-10 Yr Bond Inversed Index: ICE U.S. Treasury 7-10 Year Bond 1X Inverse Index is designed to provide the inverse of the daily return of the ICE U.S. Treasury 7-10 Year Bond Index (IDCOT7). ICE U.S. Treasury 7-10 Year Bond Index tracks the performance of US dollar denominated sovereign debt publicly issued by the US government in its domestic market. Qualifying securities of the underlying index must have greater than or equal to seven years and less than 10 years remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and an adjusted amount outstanding of at least $300 million.
S&P 500 Index: The S&P 500 Index, or Standard & Poor's 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.
IBOXHY Index: iBoxx USD Liquid High Yield Total Return Index measures the USD denominated, sub-investment grade, corporate bond market. The index includes bonds with minimum 1 years to maturity,
minimum amount outstanding of USD 400 mil. Bond type includes fixed-coupon, step-up, bonds with
sinking funds, medium term notes, callable and putable bonds.
Definitions
Alpha: a return achieved above and beyond the return of a benchmark or proxy with a similar risk level.
Annualized Equivalent Yield: represents the annualized yield based on the most recent month of income distribution: (income distribution x 12 months)/price per share.
Basis Points (bps): Is a unit of measure used in quoting yields, changes in yields or differences between yields. One basis point is equal to 0.01%, or one one-hundredth of a percent of yield and 100 basis points equals 1%.
Beta measures: the volatility of a security or portfolio relative to an index. Less than one means lower volatility than the index; more than one means greater volatility.
Convexity: A measure of how the duration of a bond changes in correlation to an interest rate change. The greater the convexity of a bond the greater the exposure of interest rate risk to the portfolio.
Correlation: a statistic that measures the degree to which two securities move in relation to each other.
Coupon: is the annual interest rate paid on a bond, expressed as a percentage of the bond’s face value.
CUSIP: An identifier number that stands for the Committee on Uniform Securities Identification Procedures assigned to stocks and registered bonds in the United States and Canada.
Duration: measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.
GNMA: Government National Mortgage Association
FNMA: Federal National Mortgage Association
FHLMC: Federal Home Loan Mortgage Corporation
Short Investment (Shorting): is a position that has been sold with the expectation that it will decrease in value, the intention being to repurchase it later at a lower price.
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