| Performance As of December 31, 2024 |
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|---|---|---|---|---|---|---|---|
|
Total Returns |
Average Annual Total Returns |
|||||
Composite/benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
10 Yr. | Since Inception |
BBH Intermediate Fixed Income Composite (gross of fees) |
-1.13% |
4.44% |
4.44% |
0.91% |
1.98% |
2.34% |
5.69% |
BBH Intermediate Fixed Income Composite (net of fees) |
-1.20% |
4.19% |
4.19% |
0.66% |
1.72% |
2.08% |
5.43% |
Bloomberg US Intermediate Government/Credit Index |
-1.60% |
3.00% |
3.00% |
-0.18% |
0.86% |
1.71% |
5.30% |
Strategy Inception: 10/01/1997 Past performance does not guarantee future results. Returns of less than one year are not annualized. |
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Bloomberg US Intermediate Gov/Credit Index is a broad-based flagship benchmark that measures the non-securitized component of the US Aggregate Index with less than 10 years to maturity. The index includes investment grade, US dollar-denominated, fixed-rate treasuries, government-related, and corporate securities. One cannot invest directly in an index. Sources: Bloomberg and BBH & Co. |
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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% vs. 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 economic 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 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. 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.
Exhibit II: Market outlook bysector as of December 31, 2024.
Performance
The portfolio outperformed its benchmark during the quarter on the heels of favorable credit selection results, sector and rating emphases, and modestly defensive duration positioning in an episode of sharply rising interest rates.
The portfolio’s active interest rate exposures had a positive impact on relative returns. Our credit selection process led us to opportunities in shorter-term corporate bonds, and that positioning created a modest underweight to duration that contributed to relative performance as interest rates rose.
Security selection impacted relative performance favorably during the quarter. Holdings of corporate bonds issued by specialty finance companies and banks were additive to results, as well as positions in single-asset, single-borrower (SASB) CMBS. There were no subsectors with measurable, negative impacts on selection results during the quarter.
The portfolio’s sector and rating emphases contributed slightly to relative results during the quarter due to the portfolio’s overweight exposure to strong-performing segments within its holdings of ABS and CMBS.
Exhibit III: Attribution as of December 31, 2024, showing average portfolio weight and gross contribution displayed in basis points.
Transaction summary
We found one new credit for the portfolio in an otherwise challenging valuation environment. We purchased a position in the AAA-rated bonds of a floating-rate, SASB CMBS deal secured by 11 student housing properties.
Exhibit IV: Notable transactions as of December 31, 2024.
Characteristics
At the end of the quarter, the portfolio’s duration was 3.5 years and continued to approximate that of its benchmark. The portfolio’s sector and rating distributions were little changed quarter over quarter. The portfolio’s yield to maturity was 5.0% and remained elevated vs. intermediate maturity bond market alternatives. The portfolio’s option-adjusted spread was 59 basis points2 over Treasuries
Exhibit IV: 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.
1 Our 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.
2Basis 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.
DEFINITIONS
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 par amount outstanding and with at least one year to final maturity.
Bloomberg 1-10 Year Municipal Bond Index is a component of the Bloomberg Municipal Bond index, including bonds with maturity dates between one and 17 years. The Bloomberg Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.
Bloomberg ABS Index is the asset backed securities component of the Bloomberg U.S. 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.
The ICE BofA 1-3 U.S. Year Treasury Index is an unmanaged index that tracks the performance of the direct sovereign debt of the U.S. Government having a maturity of at least one year and less than three years.
Bloomberg U.S. 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.
The Indexes are not available for direct investment.
“Bloomberg®” and the Bloomberg indexes are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the BBH Strategies. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the fund.
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.
RISKS
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax.
The value of some bonds including asset-backed and mortgage-backed securities may be sensitive to changes in prevailing interest rates that can cause a decline in their prices. Although mortgage-backed securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations. Mortgage-backed and asset-backed securities have prepayment, extension, and interest rate risks.
Single Asset-Single Borrower (SASB) securities lack the diversification of a transaction backed by multiple loans since performance is concentrated in one commercial property. SASBs may be less liquid in the secondary market than loans backed by multiple commercial properties.
Investments 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 stock or bond investments.
Brown Brothers Harriman & Co. (“BBH”) may be used 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. 2025. All rights reserved.
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