RISR Commentary for January 2024
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 4.15% based on the closing market price (2.74% based on net asset value or “NAV”) in January. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inversed Index) returned -0.04% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned -0.27% during the same period.
Despite generally rising for the most of the month, reaching just shy of 4.2%, interest rates made a sharp reversal during the final week, that brought 10-year Treasury back to where it started the month—right around 3.9%. The reasons for the reversal included a handful of mildly softer economic numbers on January 30, and then another bungled messaging opportunity by Fed Chair Jay Powell on January 31. Powell once again was unable to simply “stick to the script” from the full FOMC memo. Instead, in the press conference following the “no change in policy rates” announcement, he extemporaneously mused about how the economy and Fed policy might evolve, and needlessly and carelessly introduced a dovish spin to the market. This tendency to undermine the full Committee’s 2:00 statements at the 2:30 press conference has been an ongoing feature (or is it a bug?) with Powell. It tends to exacerbate volatility, as it did again in January.
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%.
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The reason rates had been rising since Christmas, was a growing recognition that despite certain measures of inflation nearing the Fed’s targets, other measures of economic vigor have persisted. In particular, the labor market remains exceptionally strong. This became abundantly apparent just after month end, when the January change in non-farm payrolls was announced. Instead of the 185,000 new jobs expected, the actual number came in at 353,000. In addition, December was revised up significantly. The January 2024 print was the highest number of new jobs added since the prior January 2023.
In addition, the composition of new jobs was supportive for robust future economic growth. As the graph below shows, in recent months the largest contributors to new jobs have been in Education & Health Services; Traded, Transportation and Utilities; plus Professional & Business Services. New jobs in the government have been steadily declining for the past two quarters.
This broad-based job growth is why the Fed’s job isn’t yet done. This is not to say that we need to see outright job losses before we can confidently claim that inflation is tamed for this cycle. Rather that, in light if such robust growth, policy makers need to extremely certain that inflationary pressures are truly tamed. A few months of lower CPI, or PPI prints, is not enough evidence to sound the
all-clear.”
Outlook
We have mentioned several times in recent communications the risks facing commercial real estate (CRE). To state it plainly, many billions in maturing CRE mortgages cannot be refinanced due to declines in operating metrics such as occupancy, and of course higher interest rates. A number of prominent real estate managers have stated their view that unless the Fed starts to cut interest rates soon, this could have catastrophic effects on the CRE sector, on banks and the broad economy.
However, there is a large problem with this line of thinking. As the graph below shows, historically, once the Fed starts to cut rates, long term rates tend to rise even as short rates decline. This steepening of the yield curve means that even if the Fed were to cut rates tomorrow, CRE mortgage rates, which are long-term rates, would likely not fall much and could even rise further.
As the graph above shows, once the Fed Funds rate (white line) begins to decline, very shortly after, long rates (blue line) rise above short rate (red line). So even a rapid decline in the fed’s policy rate, unlikely in our view, would not solve the CRE refinance problem. This is a major headwind working against financial market stability in 2024-2026.
While inflation and interest rates have receded from the absolute peaks of the last couple of years, one thing that remains elevated is volatility. Uncertainty about Fed policy, the upcoming presidential election, an increasing recognition that commercial real estate is going to be a serious problem, the growing number of geo-political hotspots that keep flaring up: all of these and more are contributing to an environment of increased volatility in asset prices. While a certain type of fast-money trader thrives on volatility, for most institutional and retain investors, volatility is something to be managed, avoided, and reduced where possible. That is one of the principal challenges of investment management. Earning a reasonably attractive return over time, while not being subject to more volatility than necessary is a primary goal for most investors.
Many investors will be familiar with the VIX index, that tracks volatility in the stock market. Less well known is the MOVE Index which tracks bond market volatility by looking at implied volatility in market-based basket of interest rate swaps. The graph below shows how elevated this index remains.
Since early 2022, the MOVE index has consistently been elevated far above the levels generally seen since 2010, following the Great Financial Crisis. Since 2022, the MOVE index has average 116.7, vs. a post-GFC average of 69.9, through 2021.
This is causing no small amount of difficulty for institutions and ordinary investors to plan and structure portfolios. This is especially true for institutions like banks and insurance companies that hold large amounts of fixed income assets, as opposed to equities. Likewise, for older investors, who typically hold greater portions of bonds, and may be actively drawing on those assets in retirement, elevated levels of bond market volatility are a serious risk.
One of the main measures of interest rate risk, one that RISR was designed to help manage is “duration.” Duration measures the sensitivity of an asset price to changes in market rates of interest. So, for example, a bond with a duration of 7, can be expected to lose 7% of its value in response to a 1% change in interest rates. Any investor that wants to reduce risk in the face of elevated market volatility can do so by reducing the duration of their portfolio. There are a number of ways of doing that, but for many of those there is a cost in terms of return.
RISR is designed to have a negative duration. This means that when interest rates increase, the value of RISR’s portfolio tends to increase, instead of decline. Therefore, by adding RISR to an existing portfolio, investors may be able to restore an overall duration profile, that can offset some of the heightened volatility in the market. And it can do so while generating an attractive consistent dividend yield.
Our view is that the volatility exhibited in the graph above is likely to be with us for some time to come. All one has to do is observe the extraordinary market swing that attend to every utterance From a Federal Reserve of Treasury official. In addition, there are some other very large economic, demographic and political forces at work in the domestic and international economies. The world is simply a more volatile and dangerous place than it was thought to be not so long ago. At the same time, there is a marked decline in the confidence and trust that populations in the West have about the ability of policy makers to address these risks.
Consequently, we see a continuation of market volatility, and the potential for rates to surprise to the upside. For that reason, we think it still makes a great deal of sense for a broad range of investors to hold at least a portion of their assets in strategies like RISR, that can dampen overall portfolio volatility without sacrificing current income. While it may be satisfying for some to make bold predictions about a Fed pivot to lower rates, the weight of history doesn’t support that position. Indeed, the greatest likelihood, measured by historical norms is for a normalized yield curve, where long-term rates are above short-term rates.
The obsession in the financial press, and especially on TV outlets such as Bloomberg and CNBC, about when the Fed will start to cut rates, is unserious and unimportant to most investors. We continue to urge savvy investors to think about a time horizon measured in quarters and years rather than weeks or months, with plenty of bumps along the way. Risk management continues to be the correct posture. Managing credit exposure and duration ought to remain top priorities, and we believe RISR can help in that effort. We are happy to speak with any investors seeking more detailed information regarding our holdings and risk/reward profile.
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 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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