MWTIX – Q4 2017 Commentary
The MetWest Total Return Bond Fund performed generally in line with the Barclays Aggregate during the fourth quarter and the full year in 2017. The slight lag in performance came as a result of the fund’s defensive positioning with an underweight to corporate credit and an emphasis on quality sectors.
Market Overview:
– A lot went right for the markets in 2017 with almost “Goldilocks” scenario in open markets
o saw ongoing global central bank accommodation
o largely inflation-free economic growth also helped propel risk assets higher
– Most U.S. macroeconomic data was decidedly positive to end the year
o improved measures of job creation, retail sales, industrial production, and capacity utilization
– Washington agreed on a comprehensive tax reform bill providing for a substantial cut in corporate taxes as well as lower personal income taxes
o This comes at a time when unemployment is already low, adding stimulus to an economy already showing momentum
– Despite an increase in economic activity, CPI pressures remained low with the latest CPI gain coming in at 1.7%, below the nominal 2% target
– Above all, volatility remained dormant throughout the year even with ongoing headline risks
– Investors continued to reach for yield throughout the year propelling markets higher
o The Agg gained 3.5% during the year despite steady increase in short term yields
– Investment grade corporate credit benefitted from strong demand and returned 6.4% in 2017
Performance Review:
– MWTIX returned 0.38% in the fourth quarter, performing in line with the Agg
o Performed just behind the Agg for the year
– Defensive duration positioning contributed modestly to relative performance
– Small contributions came from the fund’s relative overweight to government guaranteed student loans and commercial MBS
– Non-agency MBS was additive, particularly issues backed by subprime collateral
– Detractor came due to an underweight to corporate credit and conservative positioning within corporates as they performed well
– Emphasis on banking and REITs boosted returns
o Continued underweight to tech and commodities detracted
Market Outlook:
– Believe that risks are abundant below the surface, particularly within the below investment grade universe
o Increasingly aggressive underwriting standards including worsening covenant quality
– The team believes that investors appear too complacent with regards to these risks
o Willing to accept lower and lower yield compensation for the risks being taken
– With compensation near historical lows, risk appears meaningfully mispriced with limited upside
– With tax reform, markets generally view the package as simulative to GDP
o Analysts predict a GDP bump of .2 – .5%
– Fed’s normalization process has thus far been transparent and generally uneventful
o Cumulative effect of rate hikes is a concern as monetary policy works with lags that can be long and variable
– As we have seen in the past, the economy and markets can appear to be unaffected by Fed tightening for a period of time but ultimately succumb to impact of tighter credit
– Fund remains true to its disciplined, value base approach
o Focus on higher quality, more defensive areas of the market with shorter duration
– Continue to look for opportunities to add yield while avoiding credit risk
o Securitized products remain an emphasis and positioning favors quality senior issues
– Legacy non-agency MBS remains one of the most attractive sectors given the improving fundamentals
o One of the few places where leverage is decreasing rather than increasing
– With wariness of embedded risks in the corporate markets, fund emphasizes more defensive sectors like REITs, large U.S. banks, utilities, and pharma
Performance Overview:
