March 02, 2022
In last month’s newsletter we stated that, “Roosevelt Capital Management (RCM) expects to continue to meaningfully outperform the overall bond market and our benchmark.” We also promised to provide our own perspective for 2022. While we will take each issue in turn, let’s first set the stage for what has happened across the markets so far in 2022.
Setting the Stage
As nearly every reader certainly already knows, the U.S. is experiencing significant inflation that is proving to be higher and more enduring than generally expected, and the Federal Reserve’s response to this inflation will be to increase the Fed Funds rate and likely reduce the size of its $8 trillion balance sheet. While the Fed has yet to begin hiking or tapering, because markets are a “discounting” machine - they take the collective expectations of all market participants and convert them into a price today – rates already began moving higher last September and increased significantly in 2022, in anticipation of the looming Fed activity. Higher interest rates act like “financial gravity.” As interest rates go up, they pull the price of everything down; the market turmoil of 2022 is proof of this.
RCM Outperforms Market and Benchmark YTD
In an environment where equities are off 9.7% year to date, RCM has started the year off consistently outperforming nearly every category of the fixed income market in general and our benchmark, in particular. While negative performance is never comfortable, it is an inevitability at certain times in the economy and we are very pleased with the portfolio’s performance over this period relative to the overall market. We expect this trend to continue. Additionally, and critically, we have sold no securities in our portfolio due to any concerns in the fundamental credit quality of our bonds. Barring changes in credit quality, which we monitor daily, bond math tells us that these mark-to-market losses will reverse over time independent of trends in the overall market.
There are four critical observations from the performance above:
- Increasing interest rates pull prices down across all markets including fixed income
- Shorter duration bonds are less sensitive to an increase in rates but are still impacted
- Ostensibly “less risky” bonds like US Government securities are not immune from market-to-market losses in these environments
- Barring a default, short duration high yield fixed income securities offer a mechanism to ride out periods of high volatility with mark-to-market losses that will reverse as the bond approaches maturity
Bond Market Outlook
How are bonds going to do over the next 12 months? We can use a very simple bond math “truth” to get a good handle on the question. The “truth” is when you invest in a bond, you know, barring a default, your worst-case return of holding the bond until its redemption. That worst case return is the “yield” at which you purchase the bond, which is a known variable today.
These are our best projections for the current state as of February 22 and no “point-in-time letter” such as this will accurately reflect our perspective for very long. Actual returns over the next 12 months will no doubt be materially different than the above for many reasons including changes in interest rates, spreads and possible defaults. What Mike and I believe we do well is understanding the present and very near future which is why we invest in short duration securities and monitor the issuers’ underlying fundamentals literally daily.
RCM Expected Returns & Inflation
With the near certainty that the Fed will significantly increase interest rates to combat inflationary pressures, by far the most frequent question we receive is how our strategy will perform in a rising interest rate environment. The short answer is we will likely generate mark to market losses for our investors in the short term, as we have done YTD, but with higher returns over the medium to longer term. How can this be if rising rates mean lower bond prices? To paraphrase Warren Buffett: “if you like hamburgers for $5, shouldn’t you like the same one more for $3? The beautiful thing about a short duration bond portfolio is that it is frequently throwing off cash through redemptions. Wouldn’t you like to redeploy that cash at a higher expected return? Another way a rising interest rate environment benefits our investors is through the market volatility that is typically associated with them. Because we are constantly optimizing client portfolios, volatility creates opportunity.
Please reach out to us with questions and comments. Thank you for trusting RCM with your capital. It is a privilege for us to serve you.
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
The performance and characteristics information contained herein is for accounts solely managed by David Roosevelt, Managing Member of Roosevelt Capital Management LLC. Investment performance and characteristics through September 2019 are for Roosevelt Investments accounts managed by David Roosevelt. Investment performance and characteristics for October 2019 and thereafter are for Roosevelt Capital Management accounts managed by David Roosevelt. The performance information has been certified by ACA Compliance through December 31, 2018 and is available upon request. The values and performance information contained herein do not reflect management fees. While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the reports, values, calculations or assumptions and encourages each prospective investor to conduct their own review of the reports, values, calculations and assumptions.