RISR Commentary for August 2024
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned -0.30% based on the closing market price (0.43% based on net asset value or “NAV”) in August. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inverse Index) returned –1.44% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned 1.44% during the same period.
The month began with a further decline in interest rates that followed the sharp decline in July. That decline was triggered by surprised factors we discussed last month, including a disappointing payroll number, and a market panic that occurred in response to actions taken by the Bank of Japan. Over the remainder of the month, however, rates churned in a 20 basis point range between 3.8% and 4.0% on the 10-year Treasury. The month closed at 3.9%, smack in the middle of that range.
The difference in price performance vs. NAV for August resulted in the Fund’s share price ending the month a discount to NAV of around 0.59%. It is not unusual for ETFs to trade at a premium or discount to NAV, but over time these tend to average out. On average over the last 12 months, RISR has traded at a 0.003% premium to NAV.
The steepening of the yield curve we have noted previously continued in August, with 1-year and 2-year rates, declining 2.5-3x as much as longer rates.
Change in Treasury Yields August-July 2024
This steepening trend tends to be beneficial for RISR, since a steeper yield curve generally keeps prepayment speeds lower than they would otherwise be. The chart below shows the 1-month prepayment speeds for a generic Fannie Mae 5.5% coupon loan pool. Last month’s speed was 7.09 CPR, which is far below the prepayment speeds observed closer to the start of this decade.[1] This is an increase of about 2.3 CPR from the recent slow speeds seen in January, but much of that is explained by seasonal effects. (Prepayment speeds are generally slowest in Winter and speed up during the Summer moving season.) But it is still below the 8-9 CPRs observed at this time last year, despite mortgage rates being materially lower than they were at that same time.
Fannie Mae Prepayment Speeds
Since RISR’s MBS interest-only holdings benefit from slow prepayment speeds, this overall environment has continued to be generally positive for RISR, and explains a large share of our YTD and 1-year performance of 13.84% and 11.38%, respectively.
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, August be worth more or less than their original cost and current performance August 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.
[1] CPR: Conditional Prepayment Rate, i.e. the annualized percentage of the loan pool balance that prepaid in the prior month, expressed as a percentage of the prior month’s beginning aggregate pool balance.
Outlook
For some time now, all eyes have been on the labor market. After a post-pandemic surge that persisted until late 2023, several indicators have reversed course. The unemployment rate, which had reached a low of 3.4%, began a gentle rise, and in August reached 4.3%. By any historical measure, this is a very low level of unemployment. The average since 1947 is 5.5%. Nevertheless, it triggered calls from some observers for emergency action from the Federal Reserve to cut interest rates. The Fed correctly ignored such pleadings, and communicated that it saw no need for drastic action.
Another economic release was perhaps a bit more troubling. The Bureau of Labor Statistics released its latest revision to prior reports, as it does each year. This revision was quite a bit larger than usual, and reduced the number of private sector jobs added by 818,000 for the period between April 2023 and March of 2024. That left average monthly job growth at a still healthy 173,500, but it was well below the 242,000 previously reported. In other words, while still strong, the job market was not as strong as had been thought. This added further fuel to the fire for those looking for a sharp pivot by the Fed.
The reality is that the labor market is still reasonably strong, although it is unquestionably softening. Job openings, wage gains, job quit rates as well as unemployment have all printed softer numbers in recent months. However, they are all still comparatively strong historically. We believe policy makers, including the Fed, understand this as well. In addition, many (albeit not all) other economic indicators are positive, including GDP growth, retail sales, consumer confidence.
One sector that continues to lag is housing. Both existing and new home sales remain depressed, despite the more than 125 basis point decline in in mortgage rates from a high of around 8% in October 2023. The consensus among mortgage market participants seems to be that it will take a mortgage rate approaching 6% to significantly boost home sales. That level would seem to be some ways off.
Source: Bloomberg, LP
Another factor keeping home sales, and prepayments, depressed is home price affordability. Home prices have more than doubled since the great financial crisis, but wages have lagged that rate materially. As a result, home affordability is lower today than it was in the last housing bubble in 2007. Restoring affordability to historically typical levels would take a very sharp decline in interest rates, that almost no one believes is likely barring some macro-economic crisis.
Source: Bloomberg, LP
For some time we have been alerting our investors to the risks around increasing market volatility. As measured by the MOVE index, which measures volatility in the bond market, volatility has been rising for more than three months. In August, the index reached the highest level observed since the beginning of the year.
MOVE Volatility Index
The MOVE index is regarded by many as an early and more reliable predictor of overall market conditions than the more well known VIX, which measures volatility in the equity market. The increase in MOVE can be attributed to several factors, some of which we have highlighted in prior communications. In no particular order we have:
Concerns about the Federal Reserve’s plans for the timing and magnitude of cuts in the Fed Fund rate.
Concerns about a potential recession in the US.
Uncertainty over the upcoming US presidential election, especially given some extraordinary policy proposals from both candidates over tax policy, tariffs and spending.
Growing geopolitical concerns, especially over growing tensions between the US and Iran, which many experts say the US is woefully unprepared militarily. Plus, there are the ongoing wars in Gaza and Ukraine that show no signs of resolution.
In this hemisphere we also have the fallout from a highly disputed election in Venezuela, and political turmoil in Argentina and Brazil.
Rapid, sharp declines in previously high-flying tech stocks, particularly Nvidia which is down 25% from its all-time high in June, Alphabet which is down 21%, and Microsoft which is down 14%. Taiwan-based TSMC, the world’s largest chip manufacturer is also down 18%.
Currency movements especially for the Japanese Yen, as discussed at length last month.
There is a great deal of wishful thinking in the markets at present over how impactful a Fed rate cut, or even a series of cuts, will be. In our view, it will be an important signal, but will do nothing to resolve most of the risk drivers noted above. Even after the Fed starts to move, there will be a great deal of uncertainty weighing on financial markets In the current environment, we believe it is extremely important for investors to keep a very close eye on risk in their investment portfolios.
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
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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