RISR Commentary for June 2024
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 0.46% based on the closing market price (0.81% based on net asset value or “NAV”) in June. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inverse Index) returned -1.30% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned 0.95% during the same period.
During the past 22 months, RISR has paid monthly dividends of at least 0.18/share consistently, with a corresponding SEC yield ranging from approximately 6% to 9%+.
June was the second month in a row, and one of only a handful of months, in which RISR’s total return performance moved in the same direction as the broad bond markets. Typically, RISR “zigs” when the rest of the market “zags.” This is because our MBS IO portfolio is designed to increase in value as rates increase, which typically drives bond prices down. Rates in June ended the month only a few basis points lower from where they started, so our positive performance resulted from a combination of current income and some price appreciation due to a modest steepening of the yield curve. A steeper yield curve is generally beneficial for IOs, because markets tend to project slower prepayment speeds when long rates increase relative to short rates.
10-year US Treasury Yield
As the graph above shows, interest rates have retraced roughly 1/3 of the 91 bps rise experienced since the beginning of 2024. As of the end of June, the 10-year rate settled at 4.397%, almost exactly the middle of the range over the last year. So the churning trend continues, based, as it is, on swinging sentiment over inflation and the Federal Reserve’s plan for its multi-year tightening cycle. When we see a few economic statistics that suggest higher inflation then rates rise in response. And when the numbers suggest inflation might be moving towards the Fed’s 2% target, then rates decline in lockstep. We have been stuck in this lather/rinse/repeat cycle for quite some time now.
Despite this lack of strong direction, we have been able to produce very attractive returns for our investors due to good tactical positioning. Over the last year, we have produced a total return of almost 16%, and 6.6% over the prior three months alone. We think this highlights the utility of RISR as a risk management tool, with low correlation to other markets, and very attractive current income.
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, June be worth more or less than their original cost and current performance June 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
The big economic story of the last several years really ought to be the growth in the labor market. The chart below shows how much greater the change in non-farm payrolls has been since 2021, as compared to the period from 2000-2019. The average over the last three years has been 344,000 new jobs, as compared to around 77,000 for the first 20 years of this century. Even if we exclude the job losses that followed the Great Financial Crisis of 2008-09, we still only averaged around 132,000 between 2000-2019.
Source: Bloomberg, LP. (n.b. excludes Q1-Q3 of 2020 due to anomalous Covid era reports.)
Despite a moderation of new jobs in recent months, the reports released this year still showed 206,000 and 310,000 for Q2 and Q1, respectively. In total in 2021-Q2 2024 almost 5.4 million new jobs were created. That is roughly the number of jobs created in the seven years prior to 2020. Put another way, since 2021, the US economy has been adding jobs at 2x the rate from earlier in the century. (Again, all of this excludes the Covid era.)
While greater employment is generally good news, it has generated significant wage pressures, that have helped fuel inflation. The excess demand for workers from both business and government has resulted in increasing bargaining power over wages for workers. However, it is still very far from recovering the losses workers have suffered for decades, when inflation is factored in. On an inflation adjusted basis, average hourly wages have barely budged in decades. Consequently, it makes sense to think that nominal wage pressures will continue to support higher overall inflation going forward.
Source: Bureau of Labor Statistics via FRED
If that thesis is correct, as we believe, then it is going to be challenging for the Fed to get inflation fully under control without triggering an outright decline in employment and nominal wages. If we take Fed Chair Jay Powell at his word, the Fed intends to strenuously avoid this outcome. Powell frequently notes the Fed’s “dual-mandate” to support price stability AND full employment.
This means the so-called “last mile” of the inflation fight is going to take longer to traverse than many market participants expect. Over the course of the year, several broad measures of inflation have come down meaningful, although they remain stubbornly above the Fed’s 2% target. Investors need to not get ahead of the actual state of the inflation battle. Moreover, even if the Fed begins to tentatively reduce the Fed Funds rate later this year, it does not follow that longer maturity rates will decline in lockstep. In fact, in prior periods when the Fed begins to ease a tightening strategy, longer term rates have generally increased relative to short and intermediate rates, as the yield curve re-steepens. RISR ought to perform very well in that scenario.
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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