RISR Commentary for April 2024
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 5.32% based on the closing market price (5.23% based on net asset value or “NAV”) in April. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inverse Index) returned 3.07% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned -2.48% during the same period.
Interest rates rose meaningfully in April, in response to several higher-than-expected prints on inflation data. Both consumer prices and producer prices came in well above expectations, providing further evidence that the Fed’s fight to get inflation back to its 2% target is far from over. As we noted last month, inflation has been essentially stuck between 3.5% and 3.8% for almost 9 months. Following these hot readings interest rates mostly reversed the rally that occurred in Q4 2023. The 10-year Treasury bond yield closed the month at 4.68%, an increase of 48 basis points, which was the highest level seen since early November.
10-year US Treasury Yield
This sustained retracement of higher rates effectively eliminated any possibility of rate cuts from the Fed in the near- to medium-term. Futures markets (which, frankly, have a poor prediction record) had been pricing in 4-6 rate cuts as recently as March. After April’s hot inflation readings, and backup in yields, futures-implied rate cuts were basically eliminated for the balance of 2024. In our view, the forecasts for multiple rate cuts were mostly fantasy, but there were market players who took them seriously.
RISR’s return in April materially exceeded the move in rates, based on beneficial portfolio composition and security selection. Since inception, the fund has significantly outperformed its benchmarks through the end of Q1 2024, as shown below. The returns are based on closing market prices.
Source: Bloomberg, LP
On an annualized basis, RISR has outperformed the 7-10 year Inverse Treasury Index (ICET7IN) by 134 basis points, and has outperformed the Bank of America Structured MBS IO Index (BAML CSIO) by 610 basis points.
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, may be worth more or less than their original cost and current performance may 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 1.13%.
For standardized performance click here.
Outlook
There has been a great deal of discussion in the media lately about why inflation jumped in early 2021, and why it has persisted so stubbornly, despite the efforts of the Federal Reserve to get it back under control. Some have blamed profiteering by corporations, and a recent report claims that oil companies colluded with OPEC to clandestinely hike oil prices. And while there may be some bad behavior contributing on the margin, the real reason is hiding in plain sight. Namely, US federal government spending has exploded.
The chart below shows clearly what has happened.
Source: FRED
The blue line in the chart shows actual government spending since 1980. Growth in spending was growing fairly consistently, even with a bump in 2008-10 following the great financial crisis of those years. The orange line shows this trend line through 2019, and also where spending would be today if that long-term trend had continued until today.
But the trend was clearly broken by Covid. Annualized spending rocketed from around $4.85 trillion in Q4 2019, to almost $9 trillion in early 2020. It has remained well above the long-term trend ever since, and in Q1 2024, was still clicking along at an annual rate of over $6.5 trillion, fully 37% above trend. In fact, Q1 2020 through Q1 2024, the cumulative amount of federal government spending above trend totals over $8 trillion. In other words, in the last four years, excess spending above trend has exceeded the total amount the government spends in a year. That is an enormous sum and is the real reason inflation has proven so difficult to tame.
One might have expected spending to come back down closer to trend once the pandemic emergency has passed. But that has not occurred. Instead, projections now are for continued rates of elevated spending into the indefinite future. Against this backdrop, the Fed has been fighting with one hand tied behind its back.
Not that the Fed tried very hard to fight back for quite a while. The chart below shows the money supply (M2) over the same period. The Fed accommodated the explosion in spending by flooding the banking system with liquidity, and even today, has withdrawn very little of that excess.
It is these basic macro-policy choices that lead us to conclude this environment of above target inflation and higher rates are going to be with us for some time to come. It is far too soon to sound the all-clear.
RISR is designed to have a negative duration, which means it tends to zig when other parts of the market zag. Therefore, by adding RISR to an existing portfolio, investors may be able to reduce their overall duration profile, and can offset some of the heightened volatility in the market. And it can do so while generating an attractive and consistent dividend yield.
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. 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 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 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 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
CSIO Index: The ICE BofA US Agency CMO Structured IO Index represents Interest Only (“IO”) tranches of all agency MBS backed CMO deals.
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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