WATFX – Q3 2018 Commentary
The Western Asset Core Bond Fund outperformed the Agg during the quarter, supported by its allocation to investment grade credit and a small allocation to dollar-denominated EM debt. The team believes that the Fed does not have a set plan for rate hikes and could adjust going forward based on economic growth and inflation numbers.
Market Overview:
– The overall U.S. bond market was flat during the third quarter and the spread sectors generally outperformed equal duration Treasuries
– The yield curve flattened during the period, as short-term yields rose more than longer term counterparts
– Second quarter GDP annualized growth was 4.2%
o This represented the strongest pace since 2014
– The acceleration in GDP growth reflected positive contributions from personal consumption expenditures, exports, federal government spending and local government spending
– Labor market continued to support the economy during the third quarter
o Unemployment rate was unchanged in July and August and fell to 3.7% in September
o This marked the lowest rate since 1969
– The manufacturing sector continued to expand and support the economy during the third quarter
– Data in the housing market were mixed during the quarter
o Existing home sales were unchanged and average home price increased
– The Fed raised rates 0.25% at its meeting in September
o This pushed the Fed’s target rate to a range between 2.0-2.25%
– Both short and long term Treasury yields moved higher during the quarter
– The overall taxable bond market returned 0.02% during the quarter
o Higher yielding spread sectors generated stronger returns during the period
Performance Overview:
– WATFX outperformed its benchmark during the quarter
– The fund’s allocation to investment grade dollar-denominated emerging market debt was largest contributor
– An overweight to investment grade corporate bonds was beneficial as their spreads narrowed
o Individual bonds that added the most value were Goldman Sachs, BofA, and Citigroup
– Over weights to CMBS and NAMBS were additive to returns as their spreads narrowed
– Yield curve positioning detracted from performance as the short curve flattened whereas the intermediate curve steepened over the period
– Reduced the fund’s allocation to bank loans and modestly pared its CMBS exposure
o Also reduced allocation to student loan asset-backed securities as their spreads tightened
– In terms of duration, maintained over weights at the 30-year and 2-year segments on the yield curve
o Added to the overweight of the 2-year portion of the curve, but slightly trimmed the 30-year overweight
Market Outlook:
– Fed officials took another step in normalization process by dropping long-standing language saying that “the stance of monetary policy remains accommodative”
o Powell said that a “wait and see” approach may be more appropriate as long as inflation expectations remain well anchored
– In the U.S. the economic picture has been better than what was anticipated
o Above trend growth, subdued inflation and a cautious Fed remain their base case
– Growth may come in between 2.5-3% for the second half of the year
o Sluggish pace of inflation will likely continue in U.S. and abroad
– Outlook for a broad and sustained global recover has been challenged on a wide variety of fronts
o They believe that global growth has subdued to a moderate level of 3.5-4.0% but do acknowledge that risks remain
– They have always characterized the global recovery as a two steps forward-one step back process
o They believe that the emerging market setback is just one of these steps back but remain optimistic in their forward view
Performance Review:
Peter Malone, CFA
Research Analyst
Direct: 617.226.0030
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square
Suite 500
Boston, MA 02109