| Performance As of December 31, 2024 |
|||||||
|---|---|---|---|---|---|---|---|
|
Total Returns |
Average Annual Total Returns |
|||||
Composite/Benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
10 Yr. | Since Inception |
BBH Core Plus Fixed Income Composite (Gross of Fees) |
-2.51% |
4.01% |
4.01% |
-0.44% |
2.55% |
3.77% |
6.26% |
BBH Core Plus Fixed Income Composite (Net of Fees) |
-2.57% |
3.75% |
3.75% |
-0.69% |
2.29% |
3.51% |
6.00% |
Bloomberg US Aggregate Bond Index |
-3.06% |
1.25% |
1.25% |
-2.41% |
-0.33% |
1.35% |
5.50% |
Strategy Inception: 01/01/1986 Past performance does not guarantee future results. Returns of less than one year are not annualized. |
|||||||
| The Bloomberg US Aggregate Bond Index is comprised of U.S. dollar-denominated investment grade fixed income securities with maturities of at least one year. The index includes corporate, government, and mortgage-backed securities. One cannot invest directly in an index. Sources: Bloomberg and BBH & Co. | |||||||
4Q Highlights
|
Market Environment
Treasury note yields rose last quarter despite the Federal Reserve’s (the Fed) campaign of cutting interest rates. The Fed cut the federal funds rate by a total of 0.50% during the quarter and 1.00% during the 2024 calendar year. Nevertheless, note yields rose across all tenors, on the quarter and for the year, driven by lower expectations for interest rate cuts in 2025. Fed funds rate expectations for the coming year were 4.00% versus 3.00% when the quarter began.
Most fixed income indexes experienced negative quarterly total returns due to the rise in interest rates. The Bloomberg U.S. Aggregate Index declined more than 3%. Excess returns to credit, however, were overwhelmingly positive as credit spreads in mainstream indexes narrowed further to their cyclical lows.
Short- and intermediate-duration fixed income indexes managed positive total returns for 2024 despite the rise in interest rates. Long-duration indexes posted negative total returns during the calendar year as the rise in interest rates offset any yield benefits. The Bloomberg U.S. Aggregate Index advanced just 1.3% in 2024, three points lower than its 4.5% yield at the start of the year. Excess returns to credit were positive across all major sectors in 2024.
Strong data does provide a tailwind to credit, although risks are emerging with looming changes to U.S. fiscal policies. Headline consumer inflation prints have been declining but remain above Fed targets. Wage growth and job openings remain higher than historic averages and could still exert upward pressure on inflation. The Chicago Fed National Activity Index remains above its recession indicator.
Corporate default rates diverged between bonds and loans, with the default rates on bonds lower and loans higher. Distressed exchanges and liability management exercises – which are undertaken by companies to avoid default but still disadvantage debtholders – are increasing. Overall, default rates for bonds and loans were steady year over year. Defaults continue to be concentrated among CCC-rated issuers, although default rates for all rating categories are below their respective long-term averages. Business loan performance appears healthy, as delinquency and charge-off rates are low and new bankruptcy filings are near pre-pandemic lows.
There are some signs of stress emerging for U.S. consumers. Loan delinquency and charge-off rates are rising to normal levels across many loan types, while the prospects of higher-for-longer interest rates and the resumption of federal student loan repayments loom as risks to straining the U.S. consumer. The increases in loss and delinquency rates remain within expected ranges and do not signal heightened risk of impairment to asset-backed securities (ABS) bondholders.
Commercial real estate headlines remain disconnected from property-level dynamics. High-quality properties have refinanced and there have been minimal losses on paydowns in commercial mortgage-backed securities (CMBS) deals.Commercial real estate woes have not had an outsized impact on banks’ commercial real estate loan portfolios to date, as delinquency rates and charge-offs have been muted.
Heavy credit issuance and narrowing risk spreads were among the biggest stories of the fourth quarter and the 2024 calendar year. Headline issuance volumes were robust across credit sectors. Net issuance, though, was more moderate in most sectors, as most 2024 issuance was to refinance existing debt. Nontraditional ABS are the exception, as the outstanding market of nontraditional ABS grew 11% year over year on the heels of a 34% surge in volumes.
Exhibit I: Fixed income index returns for various indexes as of December 31, 2024, displaying duration, total return, and excess return.
Valuations
The compression of credit spreads amid low net issuance growth and strong inflows into fixed income is suggestive of an environment where many credits’ valuations are overbought and disconnected from their fundamentals. BBH’s valuation framework1 lends credence to that theory. The framework identifies few opportunities today in traditional index segments of the credit markets. The percentage of potential “buy” opportunities is screening near cyclical low levels across most sectors. It’s declined to 4% from 7% for investment-grade corporate bonds, to 58% from 68% for corporate loans, and to 16% from 19% for high yield corporate bonds. No cohort of the 15- or 30-year mortgage-backed securities (MBS) market screens as a “buy” candidate. Away from credits in mainstream indexes, bonds of collateralized loan obligations (CLOs) and a minority of nontraditional ABS sectors have narrowed to recent lows and screen unattractively for new purchases, although most non-traditional ABS and CMBS continue to screen attractively.
There remain opportunities in select subsectors of the market. Investment-grade corporate bonds in life insurance and banking, two interest rate-sensitive subsectors, continue to offer attractive opportunities. The corporate loan market continues to offer numerous opportunities that screen as “buy” candidates. In the structured credit markets, we continue to find opportunities in a variety of ABS subsectors through our bottom-up process. Opportunities are appearing in the CMBS market as supportive property and deal-level dynamics are disconnected from the negative headlines impacting the sector.
We continue to avoid emerging markets credits due to concerns over creditor rights in most countries and the impact on their durability. We continue to avoid non-agency residential mortgage-backed securities (RMBS) generally due to poor technical factors, unattractive valuations, and weak fundamentals, underpinned by poor housing affordability, low inventory of homes for sale, and stable-to-declining home prices.
Performance
The portfolio outperformed its benchmark during the quarter on the heels of favorable sector and rating emphases and credit selection results. The portfolio’s sector and rating emphases contributed to results despite the indiscriminate narrowing of credit spreads from already-low levels. The portfolio was overweight to several strong-performing segments of the credit markets, particularly within its holdings of ABS, CMBS, and corporate issues. The portfolio’s avoidance of MBS also enhanced returns as MBS was the only major market sector that lagged behind similar-duration Treasuries during the quarter.
Security selection contributed to results. Subsectors that impacted selection positively included loans to healthcare companies and electric utilities; investment-grade corporate bonds issued by property and casualty insurers, specialty finance companies, and life insurers; and bonds from collateralized fund obligations and data center ABS. Subsectors that detracted during the quarter included loans to cable satellite companies and high yield corporate bonds issued by technology companies.
Exhibit III: Attribution as of December 31, 2024, showing average portfolio weight and gross contribution displayed in basis points.
Transaction Summary
We continued to find durable credits2 offering attractive value despite weak attractiveness of valuations of credits in indexes. The table below summarizes a few notable portfolio additions.
Characteristics
At the end of the quarter, the portfolio’s duration was 6.0 years and continued to approximate that of its benchmark. The portfolio’s weight to investment-grade corporate bonds declined to 35% from 39% and its weight to reserves increased to 18% from 15%. The portfolio’s allocation to high yield instruments remained steady at 16%. The portfolio’s yield to maturity was 6.4% and remained elevated vs. bond market alternatives. The portfolio’s option-adjusted spread over Treasuries was 171 bps3; for reference, the Bloomberg U.S. Corporate Index’s was 80 bps over Treasuries at quarter end.
Exhibit V: Characteristics as of December 31, 2024, including credit rating and sector allocation.
Conclusion
Credit investors face a choice today: keep buying expensive credit and hope that historical credit risks and pricing don’t return in the near term, or stick with valuation discipline, a longer-term view, and realism on the inevitability of a rise in credit spreads. We believe the valuation and credit disciplines embedded in our bottom-up process will help us balance caution and opportunity in this environment.
1Our valuation framework is a purely quantitative screen for bonds that may offer excess return potential, primarily from mean reversion in spreads. When the potential excess return is above a specific hurdle rate, we label them “Buys” (others are “Holds” or “Sells”). These ratings are category names, not recommendations, as the valuation framework includes no credit research, a vital second step.
2 Obligations such as bonds, notes, loans, leases, and other forms of indebtedness, except for cash and cash equivalents, issued by obligors other than the U.S. Government and its agencies, totaled at the level of the ultimate obligor or guarantor of the Obligation. Durable means the ability to withstand a wide variety of economic conditions.
3 Basis point (bp) is a unit that is equal to 1/100th of 1% and is used to denote the change in price or yield of a financial instrument.
Totals may not sum due to rounding.
The securities do not represent all of the securities purchased, sold, or recommended for advisory clients and you should not assume that investments in the securities were or will be profitable.
Issuers with credit ratings of AA or better are considered to be of high credit quality, with little risk of issuer failure. Issuers with credit ratings of BBB or better are considered to be of good credit quality, with adequate capacity to meet financial commitments. Issuers with credit ratings below BBB are considered speculative in nature and are vulnerable to the possibility of issuer failure or business interruption.
Purchase and sale information provided should not be considered as a recommendation to purchase or sell a particular security and that there is no assurance, as of the date of publication, that the securities purchased remain in a portfolio or that securities sold have not been repurchased.
Opinions, forecasts, and discussions about investment strategies are as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are not intended to be and should not be interpreted as recommendations.
RISKS
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, maturity, call and inflation risk; investments may be worth more or less than the original cost when redeemed. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Mortgage-backed securities have prepayment, extension, and interest rate risks.
Asset-Backed Securities ("ABS") are subject to risks due to defaults by the borrowers; failure of the issuer or servicer to perform; the variability in cash flows due to amortization or acceleration features; changes in interest rates which may influence the prepayments of the underlying securities; misrepresentation of asset quality, value or inadequate controls over disbursements and receipts; and the ABS being structured in ways that give certain investors less credit risk protection than others. Below investment grade bonds, commonly known as junk bonds, are subject to a high level of credit and market risks.
The Strategy invests in derivative instruments, investments whose values depend on the performance of the underlying security, assets, interest rate, index or currency and entail potentially higher volatility and risk of loss compared to traditional bond investments.
Foreign investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.
The Strategy may engage in certain investment activities that involve the use of leverage, which may magnify losses.
A significant investment of assets in one or more sectors, industries, securities and/or durations may increase its vulnerability to any single economic, political, or regulatory developments, which will have a greater impact on returns.
Illiquid investments subject the investor to the risk that she may not be able to sell the investments when desired or at favorable prices.
Portfolio Characteristics are of the Representative Account. The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the Strategy.
One basis point or bp is 1/100th of a percent (0.01% or 0.0001).
Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact John W. Ackler at 212 493-8247 or via email at john.ackler@bbh.com.
Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. Net of fees performance results reflects the deduction of the maximum investment advisory fees. Returns include all dividends and interest, other income, realized and unrealized gain, are net of all brokerage commissions, execution costs, and without provision for federal or state income taxes. Results will vary among client accounts. Performance calculated in U.S. dollars.
The objective of our Core Plus Fixed Income Strategy is to deliver excellent after-tax returns in excess of industry benchmarks through market cycles. The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the strategy. The Composite included all fully discretionary, fee-paying core fixed income accounts over $10 million that are managed to a duration of approximately 4.5 years and are invested in a broad range of taxable bonds. Accounts that subsequently fall below $9.25 million are excluded from the Composite.
Definitions
BDC Corporate is computed as an equal-weighted index of corporate bonds issued by business development companies (BDCs) that BBH holds with at least one year until legal, final maturity.
JP Morgan CLO Index (JPM CLO) is a market value weighted benchmark tracking U.S. dollar denominated broadly-syndicated, arbitrage CLOs. The index is comprised solely of cash, arbitrage CLOs backed by broadly syndicated leveraged loans. All CLOs included in the index must have a closing date that is on or after January 1, 2004. There are no weighted average life (WAL) limitations. There are no minimum tranche size restrictions.
JP Morgan Other ABS Index (Non-Traditional ABS), is an index that represents ABS backed by consumer loans, timeshare, containers, franchise, settlement, stranded assets, tax liens, insurance premium, railcar leases, servicing advances and miscellaneous esoteric assets of the The J.P. Morgan Asset-Backed Securities (ABS) Index. The JP Morgan Asset-Backed Securities (ABS) Index is a benchmark that represents the market of US dollar denominated, tradable ABS instruments. The ABS Index contains 20 different sub-indices separated by industry sector and fixed and floating bond type. The aggregate index represents over 2000 instruments at a total market value close to $500 trillion dollars; an estimated 70% of the entire $680 billion outstanding in the US ABS market.
Morningstar LSTA Leveraged Loan Index (the Index) is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market based upon market weightings, spreads and interest payments. Facilities are eligible for inclusion in the indexes if they are senior secured institutional term loans with a minimum initial spread of 125 and term of one year. They are retired from the indexes when there is no bid posted on the facility for at least 12 successive weeks or when the loan is repaid.
Bloomberg US Aggregate Bond Index is a market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $300 million paramount outstanding and with at least one year to final maturity. The index is not available for direct investment.
The Bloomberg US Corporate Bond Index represents the corporate bonds in the Bloomberg Barclays U.S. Aggregate Bond Index, and are USD denominated, investment-grade (rated Baa3 or above by Moody's), fixed-rate, corporate bonds with maturities of 1 year or more.
Bloomberg Taxable Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long-term taxable bond market. To be included in the index, bonds must be rated investment-grade (Baa3/BBB- or higher. They must have an outstanding par value of at least $7 million and be issued as part of a transaction of at least $75 million. The bonds must be fixed rate and must be at least one year from their maturity date.
Bloomberg US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Must have at least one year to final maturity regardless of call features and must have at least $250 million par amount outstanding.
Bloomberg US Long Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market whose maturity is 10 years or longer. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
Bloomberg Emerging Markets USD Aggregate Index includes USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Bonds must have at least one year to maturity and a minimum issue size of $500 million. Both investment-grade and high-yield bonds are permitted. Debt from sovereign, agency (government owned, government guaranteed, and government sponsored entities), local authority, and corporate issuers are eligibility. Bloomberg US 1-3 Year Treasury Bond Index is an index of fixed rate obligations of the U.S. Treasury with maturities ranging from 1 to 3 years.
Bloomberg US Corporate High Yield Index (BBG HY Corp) is an unmanaged index that is comprised of issues that meet the following criteria: at least $150 million par value outstanding, maximum credit rating of Ba1 (including defaulted issues) and at least one year to maturity.
Bloomberg US Intermediate Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers that have between 1 and up to, but not including, 10 years to maturity.
Bloomberg US TIPS Index includes all publicly issued, U.S. Treasury inflation-protected securities that have at least one year remaining to maturity, are rated investment grade, and have $250 million or more of outstanding face value.
Bloomberg US ABS Index is the asset backed securities component of the Bloomberg US Aggregate Bond Index. The index includes pass-through, bullet, and controlled amortization structures. The ABS Index includes only the senior class of each ABS issue and the ERISA-eligible B and C tranche.
Bloomberg US MBS Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
Bloomberg Non-Agency CMBS Index (Non-Agency CMBS) is the Non-Agency CMBS components of the Bloomberg US Aggregate Bond Index, a market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $300 million par amount outstanding and with at least one year to final maturity.
Duration is a measure of the portfolio's return sensitivity to changes in interest rates.
An index is not available for direct investment.
Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2023. All rights reserved.
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IM-15535-2024-10-29 IM-15947-2025-01-28
