1) Seix Market Insights Investment Grade Fixed Income Executive Summary yy Divergence in central bank policy drove fixed income markets, as the Federal Reserve Bank announced a long-awaited increase in interest rates. yy Increased yields in the fourth quarter led to negative nominal returns for most fixed income sectors. High quality outperformed lower quality assets during the quarter. yy Excess returns for most of the investment grade universe rebounded into positive territory after a difficult third quarter, but year-to-date excess returns remained negative for all but a few sectors. James F. Keegan Chief Investment Officer and Chairman Perry Troisi Managing Director, Senior Portfolio Manager - U.S. Government/Securitized Michael Rieger Managing Director, Senior Portfolio Manager - Securitized Assets Seth Antiles, PhD Managing Director, Senior Portfolio Manager - Global Carlos Catoya Portfolio Manager - Credit and Head of Investment Grade Credit Research Jon Yozzo Portfolio Manager - Credit and Head of Investment Grade Corporate Bond Trading 4Q15
2) Seix Market Insights Investment Grade Fixed Income Divergence in central bank policy The Fed’s long-awaited decision to raise the target federal funds rate to 0.25%-0.50%, the first increase after more than nine years, commanded the attention of fixed income markets during the quarter. In the wake of disappointing inflation figures in Europe and Japan, the European Central Bank cut its deposit rate further into negative territory and extended its quantitative easing (QE) program to March 2017 or beyond, while the Bank of Japan’s QE program continued unabated. The Fed held off from hiking rates in September but followed through in December, ratifying a divergence in central bank policy that has been anticipated for most of 2015. This divergence in central bank policy increases the attractiveness of U.S. dollar assets and the trade weighted dollar index (DXY) gained 9.3% as a result. Given the strength of the dollar and the modestly higher yields, yield differentials of U.S. Treasuries against most other developed markets have become even more compelling. These conditions are likely to support U.S. Treasuries going forward, as capital 4Q15 tends to flow where it is treated best. Demand for high quality, income producing assets remains robust and is likely to serve as a balance to foreign central bank reserve managers selling of Treasuries to defend their currencies while this policy divergence persists. Exhibit 1: Interest Rates in U.S., Europe & Japan (12/31/15) 3.02 3.0 n United States n Japan n Europe 2.5 Interest Rates (%) Yields rose as the Federal Reserve Bank (Fed) finally raised interest rates for the first time in nearly a decade. The Barclays U.S. Aggregate Index declined by 0.57% over the quarter, while the S&P 500 Index gained 7.04%, a rebound from a weak third quarter for all risk assets. The 10-year Treasury ended the quarter at 2.27%, an increase of 23 basis points (bps) from the previous quarter, but only up 10bps for the full year. Given the Fed rate increase the front end of the yield curve underperformed, with the 2-year Treasury yield rising 42bps in the fourth quarter and 38bps for the full year. 2.0 1.76 1.5 1.0 2.27 2.09 1.31 1.27 1.49 1.05 0.63 0.5 0.0 -0.01-0.35 -0.01 -0.30 0.03 -0.05 0.07 0.17 0.27 -0.5 2-year 3-year 5-year 7-year 10-year 30-year Source: Bloomberg, data pulled 1/25/16. Commodities prices remained under pressure during the fourth quarter, led again by declining prices for crude oil. While it remains popular to characterize this as a supply driven story, the decline is as much, if not more, a dynamic driven by lower demand amidst a global growth slowdown. This dynamic puts significant pressure on bonds issued by commodityproducing companies and countries alike. Muted returns in fixed income sectors Increased yields led to negative nominal returns for most fixed income sectors in the fourth quarter, with the exception of municipal bonds. Within the investment grade universe, a quality bias persisted with higher-quality bonds performing better over the
3) Corporate bond nominal returns were negative for the quarter and the full year. Despite a better performance in excess returns over the final quarter, the full year was decidedly negative for corporate bonds. Despite these headwinds, corporate bond issuance rebounded in October and November, allowing for yet another calendar year record to be set. Residential mortgagebacked securities had a more subdued quarter and year, where a solid fourth quarter performance brought the sector back to an essentially flat year in excess return terms. Commercial mortgage-backed securities experienced a tougher quarter in both nominal and excess return terms, as a fair amount of paper was for sale amidst a robust new issuance calendar. Our outlook While the Fed “dot chart” forecasts four interest rate hikes in 2016, the market enters the new calendar year only discounting two hikes. We side with the market and see less rate hikes as the more likely path. Additionally, we cannot rule out the possibility that the Fed may reverse itself altogether and return to zero or even introduce a negative interest rate policy, should financial conditions tighten too much or fundamental economic data disappoint and incite a growth scare. The economic slowdown in China remains a primary concern amongst investors, especially given the government’s attempts to institute what appears to be a stealth devaluation of its currency. We are monitoring import/export data throughout Asia in order to gain a clearer picture of the Chinese growth trajectory. Exhibit 2: U.S. Treasury Yield Curve (12/31/15) 3.5 3.0 Yield (%) quarter. Excess returns rebounded from a difficult third quarter, but the bounce was moderate and yearto-date excess returns remained negative for all but a few securitized sectors, with asset backed securities recording the best performance. 2.5 2.0 1.5 1.0 2-year 5-year 10-year 30-year Source: Bloomberg, data pulled 1/25/16. We continue to expect the yield on the 10-year Treasury to remain in the 2.0% to 2.5% range, though it is more likely to breakout below the 2.0% threshold than to exceed 2.5%. Yield differentials versus developed market sovereign debt globally supports the demand for Treasuries, even offering capital appreciation potential despite the ever present consensus for higher rates. Again, our view is that money goes where it’s treated best—and right now it’s treated best in the United States. In this environment of elevated volatility, we will continue to pursue safe income at a reasonable price.
4) Barclays U.S. Aggregate Bond Index is an unmanaged index of U.S. bonds, which includes reinvestment of any earnings and is widely used to measure the overall performance of the U.S. bond market. S&P 500 Index is an unmanaged index of 500 selected common large capitalization stocks (most of which are listed on the New York Stock Exchange) that is often used as a measure of the U.S. stock market. Trade-Weighted U.S. Dollar Index is a measure of the value of the United States dollar relative to other world currencies. Investors can not invest directly in an index. A Basis Point is equal to 0.01%. Asset-Backed Security (ABS) is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, assetbacked securities are an alternative to investing in corporate debt. Commercial Mortgage-Backed Securities (CMBS) are a type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS can provide liquidity to real estate investors and to commercial lenders. Residential Mortgage-Backed Securities (RMBS) is a type of security whose cash flows come from residential debt such as mortgages, home-equity loans and subprime mortgages. This is a type of mortgage-backed security that focuses on residential instead of commercial debt. Yield Curve is a curve that shows the relationship between yields and maturity dates for a set of similar bonds, usually Treasuries, at any given point in time. Investment Risks: Bonds offer a relatively stable level of income, although bond prices will fluctuate providing the potential for principal gain or loss. Intermediate-term, higher-quality bonds generally offer less risk than longer-term bonds and a lower rate of return. Generally, a fund’s fixed income securities will decrease in value if interest rates rise and vice versa. Mortgage-backed investments involve risk of loss due to prepayments and, like any bond, due to default. Because of the sensitivity of mortgage-related securities to changes in interest rates, a fund’s performance may be more volatile than if it did not hold these securities. U.S. Government guarantees apply only to the underlying securities of a fund’s portfolio and not a fund’s shares. The views expressed herein are as of the quarter-end specified. This information is general in nature, provided as general guidance on the subject covered, and is not intended to be authoritative. It is subject to change without notice as market conditions change, and is not intended to predict the performance of any individual security, market sector, or RidgeWorth Fund. All information contained herein is believed to be correct, but accuracy cannot be guaranteed. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decision. Past performance is not indicative of future results. ©2016 Seix Investment Advisors LLC. Seix Investment Advisors LLC is a registered investment adviser with the SEC and a member of the RidgeWorth Capital Management LLC network of investment firms. All third party marks are the property of their respective owners. RFRI-SEIXIG-1215