RISR Commentary for October 2023
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Performance Summary
The FolioBeyond Alternative Income and Interest Rate Hedge ETF (ticker: RISR) returned 3.03% based on the closing market price (2.43% based on net asset value or “NAV”) in October. In comparison, the ICET7IN Index (US Treasury 7-Year Bond Inversed Index) returned 1.88% while the Bloomberg Barclays U.S. Aggregate Bond Index ("AGG") returned -1.58% during the same period.
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
Something of a milestone was reached in October—the 10-year treasury rate tic’d above 5% for the first time since before the Great Financial Crisis. This was a level that only a few months prior many market observers would have ruled out. There was a widely held belief that the Fed would blink in the face of a slowing economy and retreat to cutting rates regardless of inflation. The word that best describes this consensus view is “wrong.”
10-year US Treasury Yield
Fed officials have been consistent in their messaging on this, and the noisiest market commentators have been consistent in ignoring them.
By contrast, we have taken them at their word. More importantly, we have watched closely the signals from the economy and have concluded that the inflation battle was not over, and that the economy was not slowing meaningfully. This is especially true with respect to the labor market. Employers are still having trouble finding workers to fill their open positions. Large strikes including, most significantly, the UAW, provide further indication of the supply-demand imbalance in labor markets. In short, the economy is not slowing nearly enough to cause the Fed to reverse course.
We were pleased to receive capital inflows during the month amounting to almost 10% of starting capital. In the last two months, we have increased the number of shares in the Fund by more than 30%. Indeed, we have had capital inflows in 4 of the last 8 weeks. We believe this represents a growing appreciation for the benefits RISR can have for managing risk for fixed-income investors. We will continue to present this message to the market, as our goal is to convince investors that RISR is, or should be, a core holding for prudent fixed-income investors and managers looking to manage risk without sacrificing current income.
Outlook
It is worth taking a moment to review how RISR works to help manage interest rate risk. Recall that our Fund invests in Agency issued mortgage-based interest-only securities (“MBS IOs”). As interest rate rise, mortgage borrowers are less inclined to prepay their mortgages to save on interest costs. That means those mortgages stay outstanding longer, and we receive the interest cash flows for longer. This means, in turn, that the value of MBS IOs increases as market interest rates increase. This relationship is quantified in a number known as “duration.” In short, duration reflects the price change in a security in response to a 1% change in interest rates. When the Fund was launched, we aimed for a duration of -7 to -10. This would mean a 1% increase in interest rates would lead to a 7%-10% increase in the value of our portfolio.
When we launched the Fund, the national average 30-year mortgage rate was roughly 3%. Today it is almost 8%. As a result, the so-called “refinance incentive” is essentially gone. The majority of mortgage loans outstanding today have interest rates below 6%. This means that very few mortgage loans can be profitably refinanced at current rates.
This means that the duration of MBS IOs has shrunk from a range of -7 to -10, to a range of -4 to -6. Consequently, the Fund is slightly less sensitive to future increases in market interest rates. But, importantly, it is less likely to experience large drawdowns if bonds rally (i.e., rates decline) from time to time. At the same time, there has been no noticeable reduction in the current income we receive and distribute as a dividend.
We constantly look for opportunities to add negative duration, thereby increasing the hedge value of the Fund. However, given the current market environment, and the balance of risks toward rates that are “higher for longer” vs. sharply lower rates, we are very comfortable with the current portfolio. We are happy to speak with any investors seeking more detailed information regarding our holdings and risk/reward profile.
Addendum
As of the writing of this note in early November, we must acknowledge that geopolitical events loom large on markets. There is a high degree of uncertainty about how these conflicts will evolve, although tragic loss of innocent life is assured. Historically, it is common for armed conflicts to lead to a “flight to safety” that causes investors worldwide to buy US treasury securities as a safe haven. So far, that effect has been comparatively modest. Interest rates have fallen, as buyers seek safety. But it is hard to discern a strong trend. Patience and attention are called for. It may seem insensitive to discuss such events in terms of their impact on our investment strategy. But that is our job—to manage your funds through whatever economic or political circumstances may be affecting your investments.
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. 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.
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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