RISR Commentary for April 2023
Performance Summary
The FolioBeyond Rising Rates ETF (ticker: RISR) returned 2.16% based on the closing market price (2.00% based on net asset value or “NAV”) in April. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inversed Index) returned -0.90% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned 0.61% during the same period. We achieved this performance even though interest rates ended the month basically where they started, at least for maturities beyond three years.
One reason for the lack of change was that, thankfully some might say, the Federal Reserve did not meet during the month, and spent much of April in the so-called “quiet period,” when public communication from Fed officials is limited. This led to lots of speculation about what they would do at their meeting in early May—they voted at that meeting to hike the Fed Funds rate an additional 25 bps to 5.25%. But over the course of the month, a consensus developed that inflation was not declining as quickly as some had hoped, despite definitive signs of a softening economy. Moreover, the inflationary pressures were becoming more firmly embedded in services prices, rather than goods, which many took to be a worrying sign, as services price pressures tend to be stickier than good inflation.
Pressures in the banking system persisted, however. First Republic Bank1 was the latest to fall, and was placed in receivership on May 1, after rescue efforts failed. It was ultimately taken over by JP Morgan Chase1 who paid $10.6bn for the privilege. This followed a massive $30bn deposit from almost a dozen banks earlier in the month, that did nothing to calm retail and business depositors. As was demonstrated in the Silicon Valley[1] and Signature Bank[1] failures in March, it turns out that a complete failure by bank executives to manage interest rate risk, and to make a “bet the farm” wager on zero interest rates forever, makes it really hard to turn things around when the market moves against you. We strongly suspect this will not be the last bank to fail in 2023 for similar reasons.
Name Change
When we launched RISR in October of 2021, we were strongly convinced that interest rates were going to rise materially and quickly. The financial repression that policy makers in the US and the euro-zone had engineered for decades had run its course, and we perceived the emergence of a new regime of a more normalized environment. While few would admit it publicly, policy makers were forced to acknowledge that ZIRP (zero interest rate policy) had been a historic error, that had inflated asset prices and caused massive distortions in resource allocation and wealth distributions. And beginning in 2021 it led to the most serious inflation in 40 years.
Consistent with that belief, and to communicate our conviction to investors, we elected to name the fund the Rising Rates ETF. Performance in 2022 and continuing so far into 2023 has validated our outlook. We always recognized, however, that this strategy had benefits far beyond a simple bet on higher interest rates. We understood from the beginning, that our goal to deliver a negative duration profile, low correlation to traditional strategies together with an attractive rate of current income should have appeal to a broad range of investors and investment advisors.
To that end, we have made the decision to change the name of the fund to the “FolioBeyond Alternative Income and Interest Rate Hedge ETF”, effective June 26, 2023. We are keeping the RISR ticker.
We believe this name change better reflects the utility of our strategy to a broader audience, beyond those who take a directional view on interest rates. We always discussed these benefits in direct conversations with investors, but the name change makes it clear that we intend for this fund to deliver benefits to investors looking to prudently manage risk, regardless of the general direction of rates. No matter what your view on future Federal Reserve policy, we think everyone can agree that managing risk is a smart thing to do. We intend to make it even more clear that RISR can be a useful tool in that process. If you have question about this change, please contact us to discuss our thought process.
Outlook
We have discussed in prior commentaries why we believed the talk of a Fed “pivot” to once again cutting rates was wildly off the mark. One seldom hears talk of a pivot these days, but all of that energy has been transferred to talk of a pause. The general thesis seems to be that having raised rates more quickly than at any time in recent history, the Fed should now sit back and wait to see the effects of its policy, before raising rates any further.
There are basically two schools of thought in the market. The first—the pause supporters—stress the “long and variable lags” that attend to monetary policy. It can’t be known, they argue, exactly how the series of rate hikes will affect inflation and the economy, and so one should err on the side of caution, and avoid doing undue harm with rate hikes that go too far. The second says that history of inflation shows clearly that the risks of doing too little far outweigh the risks of doing too much. Inflation doesn’t die of natural causes; you have to kill it decisively. Stab it firmly in the heart with a wooden steak like you would a vampire.
Both schools of thought have advocates on the current Federal Reserve Board of Governors. Chair Jay Powell has long been, somewhat awkwardly, trying to straddle a middle ground, with a mild but noticeable tilt toward kill the vampire camp. It is regrettable however, that his lack of strong conviction has manifested in inconsistent public messaging. This has made the Fed’s job much harder than it needed to be, as investors have concluded the Fed lacks the will to see this battle to the end.
We believe it is for this reason, that fed funds futures prices still suggest the possibility of rate cuts in the second half of 2023. There are many reasons to disregard such metrics, including on theoretical grounds. But it is a signal that many in the market follow. We think as a practical matter that, barring some major exogenous shock, there is almost no chance the Fed will actually cut rates this year. Having said that, the possibility for a pause of one or even several months in the pace of rate hikes cannot be dismissed.
It is for this reason we designed RISR to have broad appeal to a range of investors, including those who have a more sanguine view, than ours, but who also agree with 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.
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 0.99%.
For standardized performance click here
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.
Footnotes
[1] The fund does not hold a position in the referenced security.
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.
Coupon: is the annual interest rate paid on a bond, expressed as a percentage of the bond’s face value.
Correlation: a statistic that measures the degree to which two securities move in relation to each other.
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.
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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