Exhibit I: Fixed income index returns for various indexes as of September 30, 2024, displaying duration, total return, and excess return.
3Q Highlights
|
| Performance As of September 30, 2024 |
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|---|---|---|---|---|---|---|---|
|
Total Return |
Average Annual Total Returns |
|||||
Composite/Benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
10 Yr. | Since Inception |
BBH Limited Duration Fixed Income Composite (Gross of Fees) |
2.39% |
5.80% |
8.78% |
4.24% |
3.65% |
2.87% |
4.57% |
BBH Limited Duration Fixed Income Composite (Net of Fees) |
2.33% |
5.61% |
8.51% |
3.98% |
3.39% |
2.64% |
4.35% |
Bloomberg 1-3 Year US Treasury Index |
2.91% |
4.13% |
6.79% |
1.27% |
1.48% |
1.41% |
3.71% |
| Past performance does not guarantee future results Returns of less than one year are not annualized Strategy Inception: 04/01/1990 |
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| The Bloomberg 1-3 Year US Treasury Index is an unmanaged index of fixed rate obligations of the U.S. Treasury with maturitiesranging from 1-3 years. Sources: Bloomberg and BBH & Co. |
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Market Environment
Treasury rates continued to respond to investors’ predictions for forward-looking Federal Reserve (Fed) interest rate decisions during the third quarter. The Fed cut the federal funds rate by 0.50% during the quarter, and investors shifted to predicting more aggressive rate cuts of 75 basis points (bps)1 before year-end. Yields declined across all tenors as Treasury rates reflected expectations of larger and faster rate cuts, while fixed income indexes experienced strong total returns as interest rates declined. Excess returns to credit were overwhelmingly positive as credit spreads in mainstream indexes narrowed from already low levels to their cyclical lows.
Corporate default rates remain subdued and 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 rates are low and default rates are declining.
The U.S. consumer appears to be strong, with loan delinquency rates and loan loss rates rising to historically normal levels. Non-prime auto loan and credit card delinquencies and charge-offs are normalizing towards pre-pandemic levels, while other consumer loans are experiencing lower losses due to tightened underwriting standards since 2022. The increases in loss and delinquency rates remain within expected ranges for asset-backed securities (ABS) to withstand losses without risk of impairment to 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. Office delinquency rates remain elevated as return to office dynamics remain weak and continue to pressure office real estate values.
Valuations
We are finding few opportunities in traditional segments of the credit markets as the percentage of potential “buy” opportunities according to our Valuation Framework,2 is screening near cyclical low levels across most sectors. According to our valuation framework, the percentage of credits that screened as a “buy” decreased to 7% from 13% for investment-grade corporate bonds, to 47% from 49% for corporate loans, and to 19% from 20% for high yield corporate bonds. Only 1% of the mortgage-backed securities (MBS) market screens as a “buy” candidate, but opportunities within those high-coupon 30-year MBS are hard to source.
There remain opportunities in select subsectors of the market. Investment-grade corporate bonds in several interest rate-sensitive subsectors, such as life insurance, finance companies, and banking, continue to offer attractive opportunities. Nearly half the corporate loan market continues to screen as “buy” candidates with most opportunities present in smaller deals. In the structured credit markets, we continue to find opportunities through our bottom-up process in ABS, and opportunities are appearing in the CMBS market as 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 the credits’ durability. We continue to avoid non-agency residential mortgage-backed securities (RMBS) due to poor technical factors and weak fundamentals underpinned by poor housing affordability, a low inventory of homes for sale, and stable-to-declining home prices.
Performance
The portfolio’s duration profile contributed to total returns during the quarter as interest rates fell, but it detracted on a relative basis due to the portfolio’s more-defensive duration profile vs. its benchmark of one- to three-year Treasuries.
The portfolio’s sector and rating emphases contributed to relative results during the quarter. The portfolio was allocated to strong-performing segments of the credit markets, particularly within its holdings of investment-grade corporate bonds, corporate loans, and ABS. The portfolio’s sector and rating emphases contributed to relative results during the quarter. The portfolio was overweight to strong-performing segments of the credit markets, particularly within its holdings of investment-grade corporate bonds, ABS, CMBS, and high yield corporate bonds.
Security selection further enhanced results, the strongest being among the portfolio’s holdings of CMBS and ABS. Subsectors that contributed included corporate loans of wireline communication companies and large loan CMBS. Subsectors that detracted included corporate loans of healthcare and media entertainment companies.
Exhibit III: Attribution as of September 30, 2024, showing average portfolio weight and gross contribution displayed in basis points.
Transaction Summary
Despite weak attractiveness of valuations of credits in indexes, we continued to find durable credits3 offering attractive value. The purchases were made across a variety of sectors and industries. The table below summarizes a few notable portfolio additions.
Characteristics
At the end of the quarter, the portfolio’s duration was 0.9 years. The portfolio’s weight to investment-grade corporate bonds increased to 46% while other sectors’ weights decreased slightly. The weight to high yield and nonrated investments declined to 6% from 8%, were comprised primarily of credits rated “BB,” and consisted of a blend of corporate bonds and loans. The portfolio’s yield to maturity was 5.7% and remained elevated vs. short-term bond market alternatives. The portfolio’s option-adjusted spread was 126 bps over Treasuries; for reference, the longer-duration Bloomberg U.S. Corporate Index’s was 89 bps over Treasuries at quarter-end.
Exhibit V: Characteristics as of September 30, 2024, including credit rating and sector allocation.
Concluding Remarks
Credit conditions are disconnected from the U.S. political headlines garnering attention. Inflation, corporate defaults, loan losses, and loan delinquencies have normalized to manageable levels. Risk spreads decreased to cyclical lows, suggesting investor exuberance may be creeping into some deals. The Fed’s rate cuts do not appear to be driven by concerns over a weak economy; rather, the cuts should help to ease restraints imposed on consumers and businesses. Given already strong credit conditions in many sectors, this may be a positive for many borrowers. The biggest risk facing credit investors may not be losses driven by macroeconomic weakness, but rather inattentiveness to valuations and durability during a period of ebullience. We believe the valuation and credit disciplines embedded in our bottom-up process are essential for navigating this environment.
1 Basis points (bps) is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
2 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.
3 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.
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
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.
Duration is a measure of the portfolio’s return sensitivity to changes in interest rates.
An index is 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 indexes (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 Strategy. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the Strategy.
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.
SASB lacks 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.
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.
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 Limited Duration Fixed Income Strategy is to deliver excellent returns in excess of industry benchmarks through market cycles. The Composite includes all fully discretionary fee-paying accounts with an initial investment equal to or greater than $10 million with a duration of approximately 1.5 years. Accounts that subsequently fall below $9.25 million are excluded from the Composite.
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. 2024. All rights reserved.
Not FDIC Insured No Bank Guarantee May Lose Money
IM-15520-2024-10-28 Exp. Date 01/31/2025
