July 27, 2022
Dear Investors and Friends,
In our last letter we introduced our readers to our description for and explanation of the current downturn, “The Great Reset.” The trend that we highlighted continued through the end of the quarter with nearly all financial assets down significantly. This month we dive into how The Great Reset has impacted RCM’s short duration high yield corporate bond composite through the first half of the year. The chart below compares our performance vs. our index and the overall bond market and shows that we were not immune from the selloff.
We have several observations.
First, despite consistently beating our benchmark and the market, we are disappointed by our recent absolute performance for 3 reasons:
- We loathe reporting negative performance, although doing so is occasionally a necessary evil of long-only investors as cycles are a simple fact of life.
- We seek to beat our benchmark by 200 basis points annually. Although we beat the benchmark, year-to-date we underperformed our goal by 21 bps and over the last twelve months by 20 bps.
- RCM invested in two credits which significantly underperformed. Our thesis on one changed because of new information so we exited the position. The fundamentals on the second remain intact.
Second, the vast majority of the losses you are seeing are mark-to-market declines. Unlike an equity where prices can decline and remain low indefinitely, a bond's price will, barring a default, always return to its par value as it approaches maturity. We fully expect these mark-to-market declines to reverse over time.
Third, we have consistently said that an environment such as this, while challenging, should allow us to generate higher returns for investors over the medium to long term, all else equal. Now that we are here, we acknowledge the pain, but stand by the comment. Let us explain. Before we were investing capital at a yield of ~ 5%. Today we are investing capital at ~ 8%. Assuming a 5-year horizon, what would you prefer: a) 5% for 5 years, or b) 8% for 5 years plus 8% losses? The former adds up to $25 while the latter adds up to $32. So, even with the 8% losses experienced now, this simple example shows that you come out ahead.
Fourth, some clients have asked us for an explanation of the losses. Qualitatively the RCM short duration high yield composite is lower for two reasons: inflation and recession fears. The mechanism by which inflation lowers bond prices is as follows.
A back of the envelope method to quantify how higher interest rates impacted the value of RCM’s portfolio is to multiply the year-to-date change in interest rates, approximately 2%, by the duration of RCM’s portfolio, approximately 3 years, or 6%. For a detailed explanation of duration please see our March 2021 letter.
The mechanism by which recession fears lowers bond prices is as follows.
A back of the envelope method to quantify how higher spreads impact the value of RCM’s portfolio is to multiply the change in spreads, also approximately 2%, by the duration of RCM’s portfolio, approximately 3 years, or 6%.
Adding the impact of interest rate and spread movement with the year-to-date income generated from the portfolio of approximately 3% indicates that RCM should have been down about 9% (-6% + -6% + 3%) whereas we were down about 8%. The difference between the actual and the theoretical is because of the back of the envelope nature of the calculation combined with RCM’s value add through portfolio optimization.
Fifth, we have been asked how we consistently outperform our benchmark? RCM adds value in three ways. First, our portfolio has a higher yield than the benchmark. Second, our portfolio generally experiences fewer losses than the benchmark. And third, we are constantly optimizing the portfolio by selling lower yielding bonds and replacing them with higher yielding bonds of acceptable credit quality.
And last, Mike and I are often asked “is now a good time to be allocating capital to RCM?” While we are sometimes equivocal in our answer, that is not the case today. Yields and spreads provide one of the best entry points into the short duration high yield corporate bond market that we have seen in years.
We would like to close this letter by acknowledging the pain that you and we (Mike and I also have a significant amount of our own net worth’s dedicated to this strategy) are experiencing but want to encourage you with 3 facts. First, US markets have been down significantly many times before and have always recovered. This time is no exception, we are simply in a period of re-adjustment. Second, RCM has a proven process in place to beat its benchmark and we will continue to diligently implement this process in the future. Third, the biggest mistake that long-only investors make is to sell out of fear when the market is down. Mike and I are not only not selling but excited by the opportunities presented by this down market.
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
GIPS Claim
Roosevelt Capital Management claims compliance with the Global Investment Performance Standards (“GIPS®”) and has been independently verified by ACA Performance Services, LLC (“ACA”) for the period of October 1, 2019, through December 31, 2021. What follows is the required GIPS composite report.
Roosevelt Capital Management
Short Duration High Yield Corporate Bond Composite
January 2012 to December 2021
Disclosures
- Roosevelt Capital Management claims compliance with the Global investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Roosevelt Capital Management has been independently verified for the periods October 1, 2019, through December 31, 2021. A firm that claims compliance with the GIPS standards must establish policies and procedure for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm's policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Short Duration High Yield Corporate Bond Composite has had a performance examination for the periods October 1, 2019, through December 31, 2021. The verification and performance examination reports are available upon request.
- Roosevelt Capital Management is a registered investment adviser in the States of Texas, South Carolina and Louisiana. Roosevelt Capital Management is an independent investment management firm that is not affiliated with any parent organization. Roosevelt Capital Management ported the Short Duration High Yield Corporate Bond Composite prior to October 1, 2019.
- The Short Duration High Yield Corporate Bond Composite includes all fee and non-fee-paying accounts that invest primarily in short duration high yield corporate bonds, independent of concentration, and that are deemed to be discretionary. Key material risk is that bond prices decline, for myriad underlying reasons, resulting in underperformance vs. the benchmark.
- Performance prior to October 1, 2019, occurred while the investment management team was affiliated with another firm. Firm assets prior to 2019 are not presented because the composite was not part of the firm. The investment management team has managed the composite since its inception, and the investment process has not changed. The historical performance has been linked to performance earned at Roosevelt Capital Management and has been reviewed by an independent third party. The performance certification opinion letters are available upon request.
- The benchmark from May 1, 2010, through present is the Markit iBoxx USD Liquid High Yield 0 – 5 Year Index. The index consists of liquid USD high yield bonds, which provide a balanced representation of the USD denominated short duration high yield corporate bond universe. The index is market-value weighted with an issuer cap of 3%. The benchmark from January 1, 2010, through April 30, 2010, which is only used for 4 months of the 3-Year Standard Deviation calculation, is the Bloomberg US Aggregate Bond Index. The index is a broad-based flagship benchmark that measures the investment grade, USD denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related, and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
- Returns presented are time-weighted returns. Valuations and performance are reported in US dollars. Gross-of-fees returns are presented before management fees but after all trading and other expenses. Net-of-fees returns are calculated using a model investment management fee of 0.75% per annum and applied monthly.
- Performance is presented to reflect the re-investment of income.
- Policies for valuing investments, calculating performance, and preparing GIPS reports are available upon request.
- A list of composite descriptions is available upon request.
- The composite was created on October 1, 2019, and the inception date is May 1, 2010.
- Internal dispersion is calculated using the equal-weighted standard deviation of annual gross returns of those portfolios that were included in the composite for the entire year. This statistic is not presented for periods with less than 6 portfolios within the composite for the full year.
- The three-year annualized standard deviation measures the variability of the composite gross returns, and the benchmark returns over the preceding 36-month period. This statistic is not presented for periods with less than 36 months of composite performance.
- Prior to October 1, 2019, the firm elected to create a carve out of corporate bonds from the firm’s blended fixed income portfolios. At the time, the firm did not manage any portfolios solely dedicated to the short duration high yield corporate bond strategy. Cash is allocated to the strategy based on the strategy target cash weight of 5%. Cash returns are based on actual returns on firm cash balances for the period. Effective October 1, 2019, the firm has discontinued the use of carve outs with allocated cash balances for this composite. Alternatively, the firm utilizes sub accounting to manage the corporate bond assets separately from the blended fixed income portfolios. Each sub account is managed with its own cash balance.
- Effective October 1, 2019, portfolios are removed from the composite if they have a significant cash flow. A significant cash flow is defined as a contribution or withdrawal of cash or securities greater than or equal to 15% of the beginning market value of a portfolio. The portfolio is removed from the composite for the month in which a significant cash flow occurred.
- Effective October 1, 2019, portfolios are removed from the composite if they have an allocation in corporate bonds less than 33.3% of the beginning market value of the portfolio. The portfolio is removed from the composite for the month in which it has an allocation less than the threshold.
- Effective October 1, 2019, portfolios are removed from the composite if they have a market value including accrued interest that is less than $100,000. The portfolio is removed from the composite for the month in which it has an allocation less than the threshold.
- 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.
- RCM’s stated fee schedule for the strategy is 0.75% per annum paid monthly in cash in arrears. Actual fees may vary.
- Past performance does not guarantee future results.
Other Disclaimers
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.