TCPNX – Q4 2017 Commentary
The Touchstone Total Return Bond Fund outpaced the Agg during the fourth quarter and in 2017. The fund attempts to be duration and yield curve neutral relative to the Agg. During the year, the strategy benefited from a slight overweight to credit but maintains positions in more defensive credit sectors.
Market Overview:
– Economic data continued to be strong during the fourth quarter
o Employment reports signaled improving job market and unemployment fell
– Despite overall job market strength, inflation continued to register below 2% target
– New tax reform bill was passed and signed into law at the end of the quarter
– The Fed remained confident enough in the economy to raise rates in December
o Rate hike was largely anticipated by the market as rates on short term Treasuries steadily increased throughout the period
– Yield curve flattened as 30 year rates declined more than 10 year rates
o Market returns generally were driven by tightening of spreads and flattening of the yield curve
– During the quarter, the Agg posted positive returns and outperformed duration-matched Treasuries
– Credit sensitive sectors such as corporates, CMBS, ABS, and munis had a favorable backdrop
o Credit performed best as it was tied most directly to economic success
– U.S. agency bonds also delivered excess returns which exceeded expectations
Performance Overview:
– Touchstone Total Return outperformed the Agg for the quarter
– Combination of low interest rate environment and positive economic developments support the demand for spread products within the bond market
o This was the primary tailwind to fund performance during the quarter
– Fund’s slight overweight to credit was a positive contributor to performance
o Preference for slightly more stable industries slightly offset the performance benefit
– The fund complemented single family MBS with Agency multi-family MBS during the quarter
o This contributed to relative performance
– The fund does not make active interest rate bets and approximately matched Agg duration
o Fund’s interest rate risk was therefore effectively equal to the bench over time
– While twists in the yield curve impacted total returns during the quarter, the fund was approximately curve neutral
o With this approach, changes in the yield curve had little effect on relative fund performance
Market Outlook:
– The team expects 2018 to be a fairly heavy year for U.S. Treasury issuance unless economic growth is significantly higher than prevailing projections
– Anticipate the new tax reform bill will also lead to new source of Treasury supply
o Fed has started to reduce the size of its balance sheet which is almost entirely comprised of Treasuries and single family MBS
– Fed is also the largest buyer of Single Family MBS which provides another opportunity for supply and demand imbalances
o If imbalances occur in a meaningful way, team expects interest rates to rise
– The team has chosen to underweight U.S. Treasuries and Single-Family MBS
o Believe the fund’s allocation to Multi-Family MBS is more advantageous as the sector does not require the Fed’s support and is not part of the balance sheet
– With tax reform further fueling investor optimism, we believe a sudden slowdown in the economy could catch many investors by surprise
o This could reduce the demand for some spread products
– Believe the fund is well positioned well and maintain a discipline that balances risk and return objectives
Performance Review:
