RISR Commentary for December 2024
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 3.65% based on the closing market price (3.88% based on net asset value or “NAV”) in December. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inverse Index) returned 2.27% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned -1.64% during the same period.
2024 was an eventful year for RISR. Our total return of 24.16% in 2024 marked the Fund as the top performing Alternative Fixed Income ETF among those tracked by Bloomberg and Morningstar. We hit our 3-year anniversary since inception, which is a milestone most ETFs never make, and which opens the Fund to potential investment by numerous large allocators who require a 3-year track record to invest. Finally, RISR received a 5-star overall Morningstar rating and ranked #1 among 260 funds in Morningstar’s Nontraditional Bond Funds category over a 3-year period ending on 12/32/24. The rating and ranking are based on Morningstar’s methodology of comparing risk-adjusted returns.
This performance was achieved even though the Federal Reserve began to unwind its multi-year interest rate raising cycle, with total cuts of 75 bps in the Fed Funds rate during 2024. Despite this long-anticipated move by the Fed, RISR generated a full year return that greatly exceeded the broad bond index, and was close to the tech-heavy broad equity index.
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, December be worth more or less than their original cost and current performance December 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 1.23%.
For standardized performance click here.
The Fund’s performance this year was driven in part—but not exclusively—by an increase in long term interest rates that occurred despite long-awaited “pivot” in Federal Reserve policy to rate cuts after more than two years of rate hikes. The chart below plots the course of the 10-year Treasury bond, which started the year at 3.94% and ended at 4.57%, an increase of 64 bps for the full year.
10-Year Treasury Bond Yield
Perhaps the most notable feature of the trajectory in rates in 2024, was the tremendous bond-market rally that occurred between April and September. The low of 3.69% in mid-September, convinced many observers that a new bull market had begun. Of course, we now know (as we stated forcefully at the time) it was the mother of all head fakes. There is an expression among seasoned professional investors that goes: “The market will do whatever causes the most pain to the most people.” It is usually stated only slightly tongue in cheek. There is a good deal of truth in the aphorism, because crowded trades, where a large proportion of market participants take a similar position, tend to hold the seeds of their own destruction. This can happen for a variety of reasons, but in many cases, a surprise event that calls into question the crowded trade thesis leads to a stampede for the exits. That is what happened in September and continued through Q4. Several economic releases, as well as continued muddled messaging from the Fed, spooked investors. This led to a rush from the “rates have peaked” thesis, with the sharp rebound in rates during the last quarter of the year.
RISR greatly outperformed the total move in rates over the course of the year. If we deduct the 6.5% income component of performance that leaves price performance of a little less than 18% (24.2% – 6.5%). That is far greater than the theoretical duration-implied price performance that could have been expected from a static portfolio. The modelled duration of the portfolio averaged around negative 5.5 years. Combining that with a 64 bps movement in the 10-year treasury rate, over the course of the year, would suggest expected price performance of around 3.5% (5.5 x 0.64). Instead, through active management and security selection, we were able to add substantial additional returns.
Presumably due to this strong performance, as well as the 3-year anniversary and the Morningstar rankings announcement, the fund saw significant inflows in the latter part of the year. We began 2024 with total assets of approximately $56 million. We ended with around $78 million. As of this writing, we now have assets of about $113 million. This is another important milestone, since some large investment platforms look for assets of at least $100 million, before they add coverage on their systems. We have ongoing discussions with these parties to encourage them to make RISR available to their clients and subscribers.
While it is impossible to predict, we have had conversations with several prospective investors that make us hopeful this trend in asset growth will continue. As assets have grown, so has liquidity. Daily trading volumes have been greater and bid-ask spreads have been tighter over the last several weeks. While there is little we cand do directly to improve the liquidity of our shares, we continue to engage with market makers to explain our strategy and are hopeful these positive trends will continue.
Market Outlook
A great many market commentators expressed surprise at the steepening of the yield curve that occurred in 2024, despite 100 bps of aggregate cuts in the Fed Funds rate. This reflects a lack of historical perspective because this pattern has been seen many times in the past.
Even so, the bear steepener of 2024 has been sharper than most, as seen in the chart below. The dotted line shows where the yield curve stood at the end of 2023, while the heavy green line shows the curve as of December 31, 2024. The bars on the lower axis show the basis point change of the course of the year at various maturities.
At the very short end of the curve (left side of the chart) we see the roughly 100 bps decline in yields, corresponding closely to the Fed’s 100bps reduction in the Fed Funds rate. As we scan across to the right we see the roughly 55-60 bps increase in yields at every maturity from 5 years, out to 30 years. In other words, the curve has steepened by around 160 bps, despite the widely held expectation that long rates would follow the downward path of short rates. This was always wishful thinking.
Treasury Yields YE 2024 vs YE 2023
This comes as no surprise to us. We have been advising investors that the move higher in medium- and long-term rates was occurring independently of moves by the Fed, which only has direct control over the very shortest maturities. Indeed, Fed Funds is an overnight rate. We have been telling investors for more than a year, to expect a steepening of the yield curve once the Fed did finally “pivot” from rate hikes to rate cuts. This is exactly what has happened. But why?
The US bond market is in a secular bear market. Barring a catastrophe and policy response like those seen in 2008 and 2020 in response to the global financial crisis and Covid, respectively, rates are simply not going to decline to the extraordinarily low levels seen during those emergencies. This is only partially related to current inflation, to which the Fed was very slow to respond in 2021. Inflation is still well above the Fed’s 2% target, and we believe it is likely to remain so. Indeed, it is entirely possible we will see a repeat of the pattern seen many times in history where a central bank prematurely declares victory over an initial burst of inflation, only to see it re-accelerate.
Instead, the larger forces now at work driving interest rates higher are going to be extremely difficult to reverse. They are related to the massive, one might say unprecedented, explosion in debt that has occurred in the US and elsewhere over the last 10-15 years. There is simply no precedent for such a large increase in public and private debt outside of wartime. Despite ongoing conflict in the Middle East and Ukraine, and the concomitant spending made in support of its allies, the US has not mobilized a military effort even remotely like that seen in more direct historical conflicts such as WWII.
The chart below shows the total outstanding debt of the federal government over the last 60 years. At the end of Q3 2024, it totaled $35.5 trillion, which is a six-fold increase since 2000.
This is a remarkable increase in the borrowings of the federal government. The sharp acceleration in debt that occurred in the wake of the 2007-08 financial crisis, accelerated further in response to Covid. But even though that emergency has passed, the spending and borrowing continues to grow at a rapid pace.
Of course, a growing economy should be able to support higher levels of debt. But the increase has greatly outpaced growth in GDP, as the following chart shows. Expressed as a share of the overall economy, federal debt now exceeds the levels seen at the height of WWII.
Similar charts could be produced for household and business debt. The US public and private sectors are currently more indebted than at any time in history, and the trend appears to be getting worse, not better. It is important to remember that interest rates are the price paid for credit. Like all other prices, the more demand there is—i.e. higher debt levels—the greater the cost.
After a long period of general decline, interest expense as a share of federal spending has recently been growing, and that will almost certainly continue. In fiscal 2025, it is expected to be around 19% of total federal spending. As recently as 2020 it was a little over 10%. Even this recent trend is misleading since it has been suppressed by current Treasury Secretary Yellen, through a deliberate policy of skewing federal borrowings to short-term bills and notes, rather than medium- or long-term bonds. The incoming Secretary Bessent has expressed his judgement that this is unwise as it subjects the Treasury debt management process to excessive volatility and uncertainty. Taken together, this means that an enormous amount of recently issued bills and notes will have to be refinanced in the next 12-24 months. And that refinancing will take place at higher rates of interest than the government had been paying.
To state the obvious, the credit markets are in a difficult position.
All of this is simply to explain why interest rates are likely to remain where they are today or to trend higher for longer. As investors and asset managers, we take no opinion on the choices being made to incur more public and private debt to achieve whatever objectives economic and political actors choose. For example, you may think Republicans or Democrats spend too much or too little on priority A, B or C. And you may think it is wise or unwise for investors to leverage themselves to buy equities (margin debt is near record highs). Or for families to incur large debts to pay for higher education. Or for highly levered real estate operators to continue to support commercial properties that seem unlikely to ever recover the occupancy levels they once anticipated.
Our views about debt and interest rates do not reflect a judgement about these choices. It is a dangerous mistake in investing to convince yourself that what you think should happen is what will happen. Instead, we observe the reality of economic and financial decision-making, and we allocate capital and manage risk accordingly. That is our goal with RISR. To provide investors who see what we see with a tool to manage these risks, and ultimately to profit from an allocation to this strategy. You may think the federal deficit is “too large” or “nothing to worry about” as a personal preference, but there is little doubt that at current and projected levels, it leaves little to no room for interest rates broadly to decline materially.
Conclusion – Continued Volatility
There is rapidly growing realization among investors that the fiscal situation in the US, as well as other major economies, is perilous. At exactly the time the Treasury needs more buyers for its upcoming debt issuances, those historic buyers are stepping back. The incoming Trump Administration has been very vague about their fiscal priorities, aside from some non-sensical statements about tariffs and tax cuts. Trump has also recently stated he would like to see the debt ceiling eliminated altogether. That seems extremely unlikely, since one of the few tools the opposition party has in any debt negotiation is the threat to shut down the government if the debt ceiling is breached. In the meantime, we continue to urge investors to reduce their exposure to volatility generally. In particular, reducing the duration of your fixed income holdings remains paramount. Making big directional calls, especially in favor of a material bond market rally is highly risky.
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.
The Morningstar Rating™ for funds, or "star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds and separate accounts) with at least a three-year history without adjustment for sales load. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk- Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive five stars, the next 22.5% receive four stars, the next 35% receive three stars, the next 22.5% receive two stars, and the bottom 10% receive one star. The Overall Morningstar Rating™ for a managed product is derived from a weighted average of the performance figures associated with its three-, five- and 10-year (if applicable) Morningstar Rating™ metrics. The weights are: 100% three-year rating for 36 - 59 months of total returns, 60% five-year rating/40% three-year rating for 60 - 119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. As of 9/30/2024, RISR was rated against the following number of Nontraditional Bond Funds over the following periods: 272 for the 3 year time period. RISR received 5 stars for those periods. Ratings for other share classes may differ. Past performance is no guarantee of future results.
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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