By John L. Schaefer, CFA
By Reed J. Nuttall, CFA
Chief Investment Officer
Treasury rates hit their 2013 lows on May 1. The next day, the April unemployment report posted a higher than expected gain of 165,000 jobs (revised higher to 195,000) which caused rates to move higher. By the end of May, the Federal Reserve had indicated a willingness to “taper” off the buying of Mortgage Backed Securities (MBS) and Treasury securities, and rates had increased by 50 basis points. By the end of June, there had been a continued selloff in longer duration securities moving Treasury yields higher and spreads wider across all fixed income sectors. The unemployment picture looks much better, with another 195,000 jobs added in June. However, the overall economic pace is tepid with growth expected to be below 2.0% during the second quarter.
Unexpected employment optimism leads to wider spreads and higher rates.
In this environment, the Barclays Capital U.S. Aggregate Index return for the second quarter was -2.32%, bringing the year-to-date (YTD) number to -2.44%. The worst performing sector in the Aggregate was the Taxable Municipal sector with excess returns over Treasuries of -156 basis points in the second quarter. The duration of the MBS sector extended from 4.0 to 5.2. This led to aggressive selling and underperformance as investors sold MBS in an attempt to shed duration. Corporate bonds widened as well, underperforming similar duration Treasuries by -54 basis points. Tax-exempt ETFs and mutual funds saw outflows of $14.5 billion during June bringing the second quarter return of the Tax-exempt Municipal Index to -2.97%, much worse than Treasuries. The AAM portfolios are underweight MBS and long Corporates, but the significant overweight to the spread sectors caused underperformance during the quarter.
The 10-year Treasury closed the second quarter yielding 2.49%. At these rates, the market has priced in a significant reduction of the QE3 program by the Federal Reserve. We expect the Fed to begin reducing purchases early in the fourth quarter. We believe that the Fed will keep the funds rate “at or near zero” at least through the first quarter of 2014 and expect that Treasuries will be range bound, driven either by unexpectedly strong employment numbers or by exogenous shocks to the U.S. market, coming from China or Europe. Although, we are concerned with heighted leveraged buyout (LBO) activity and we think that security selection is key, current valuations in Corporate securities are attractive. The underperformance in the MBS sector has improved these securities to “fair” versus the unattractive outlook at the end of the first quarter. We also find value in Tax-exempt Municipals and would recommend increasing allocations for all accounts that can take advantage of the tax-exempt income.
Dan Byrnes, Senior Portfolio Manager presents an economic and market update.
AAM Insurance Investment Forum in Columbus, OH
On June 26 and 27, 2013, nearly 30 investors descended upon Columbus, OH for a two-day seminar to discuss key investment issues facing insurance companies. Hosted at the offices of Grange Insurance, the inaugural event provided a forum for sharing ideas and making new connections.
The two-day event began with a golf tournament at Tartan Fields Country Club in Dublin, OH. Prizes were handed out at dinner for the lowest scoring team, longest drive, and closest to the pin.
The speaker line-up focused on addressing the most important challenges facing insurance company investors. The topics included an economic and market overview, corporate credit outlook, investment accounting update, and an open forum to discuss trends and challenges in the current environment. In addition, AAM hosted a panel with our sub-advisory relationships to discuss surplus investment growth strategies including convertible bonds, high yield, bank loans, and commercial mortgage loans.
Prior to attending the conference, participants were asked to fill out an investor survey. Results of the survey suggested that most insurers were very concerned about the continued manipulation of the financial markets by the Federal Reserve, and predictions were generally for an interest rate environment that would remain only modestly higher over the next 3 to 5 years.
AAM thanks all of the insurance companies who participated and made the two day event such a success.
Employee Spotlight: John J. Olvany
Vice President of Business Development
John brings over 25 years of experience in the financial markets to his role at AAM. Among other roles, he was a Managing Director at Morgan Stanley responsible for the Chicago institutional fixed income group where he developed a number of relationships with a variety of institutional investors including insurance companies. Most recently, John spearheaded the opening of Midwest operations for Drexel Hamilton, a disabled veteran owned and operated investment bank.
Vice President of Business Development
How did your career path bring you to business development role at AAM?
I began my career in the fixed income markets trading U.S Treasury securities in Tokyo with institutional Japanese investors in the late 1980s. After a few years of market making for clients, I realized the client interaction regarding various sectors of the fixed income markets that is integral to success in fixed income sales was my true passion. When I joined the institutional fixed income sales desk at Morgan Stanley in Chicago, the fixed income markets were in the midst of an unprecedented period of product innovations. Over the years, my clients actively invested in fixed income products that financed companies, projects, and real estate across the globe. As I look at the investment landscape for the next few decades, I am convinced that asset management companies and institutional investors are in a period of transformation due to some major global secular trends. I am extremely excited to play a role at AAM in one of these trends-outsourcing investment management duties. With insurance companies seeking excess return across more asset classes and regions due to the long-running low yield environment, I feel sales professionals will be required to explain accurately strategies and products with a high level of technical skill and investment knowledge. I am convinced that my fixed income product expertise and client relationship skills will be vital for marketing solutions to clients of AAM in this environment.
What attracted you to join AAM?
The strong team of experienced investment professionals and the focused strategy of serving the insurance industry were the principal catalysts in my decision to join AAM. Having worked with a number of our investment team dating back to the mid 1990s, I have a great deal of confidence in their investment experience and professionalism. I look forward to building the AAM brand and seeking customized investment solutions for issues facing insurers across the industry.
What do you do when you not working at AAM?
After being elected by the residents of our village, I volunteer as a Park Commissioner in Wilmette, Illinois. Working with the staff, residents, and business owners of my community to maintain and improve and parks, facilities, and programs offered by the Wilmette Park District has been a truly gratifying experience. In my leisure time, I am an avid cyclist having just completed a bicycling tour across Arkansas with my 19-year old daughter who is cycling 4,200 miles from Baltimore, MD to San Diego, CA this summer.
What’s the last book you read for pleasure?
As I turned each page, I was continually amazed by the story of world class athlete and POW, Louie Zamperini as told by Laura Hillenbrand in Unbroken-A World War II Story of Survival, Resilience, and Redemption. Having known nothing about Mr. Zamperini prior to reading Unbroken, it was difficult to imagine how he was able to survive under the extreme duress that accompanied his experience in the Pacific war.
What would people be surprised to know about you?
I honed my client service skills at an early age as a cabana boy on the shores of Long Island, NY.
AAM Thought Leadership Articles
AAM produces a number of Thought Leadership articles through out the year including focused credit market outlooks, updates on market conditions, and investment accounting updates. Below is a list of the Thought Leadership produced in the second quarter with direct links to the articles.
AAM Corporate Credit View – Second Quarter 2013
Investment grade corporate spreads tightened from 141 basis points (bps) at year-end 2012 to 130 bps in mid-May, as investors Read more…
AAM Municipal Market Perspective – Second Quarter 2013
The Tax-exempt sector was generally weaker across the yield curve relative to Treasuries during the first quarter of 2013 Read more…
AAM Market Update
The 10-year Treasury yield fell to 1.61% on May 1, 2013 on the premise of a sluggish domestic economy and QE3 extending into 2014. Concurrently, the European Central Bank indicated a willingness to become more accommodative Read more…
The Railroad Industry Hits a Gusher
The relationship between the oil and rail industries goes back over 100 years to the days of the Standard Oil Read more…
AAM in the Community
On the evening of July 11, AAM employees participated in the Bastille Day 5K & 8K Run/Walk event in Chicago. This was the third year that AAM employees have participated in this race, which is held annually in honor of French Independence Day, July 14, known as Bastille Day. Each year the event includes a 5K run/walk and 8K run/walk as well as a post race “block party.”
The race is partnered with the Mercy Home for Boys and Girls, which is an organization that mentors youths in crisis or “at risk” and gives them a positive environment to grow and realize their potential. The event is beneficial to the community and we consider it a great opportunity to spend some time with colleagues outside of the office and enjoy a summer weeknight.
AAM originally got involved with this particular race in 2011 when our audit firm, A-lign CPAs, organized a friendly competition with the winner being awarded $3,000 toward a charity of their choice. The goal was to have the lowest combined time for a four-person team in a 5K held during the third quarter of that year. The Bastille Day 5K was perfect for this competition, so we signed up. Unfortunately, AAM came in second place and did not win the charitable donation, but we enjoyed the Bastille Day event and continue to participate each year. We’re looking forward to the race and enjoying a nice night out!
All smiles after a fun run on a warm evening!
Back row: Gary Alvarez, Mike Kelch, Mark Steiger, Eric Pochyla
Front row: Stacy Crook, Brad McDonough, John Benstead, Joe Borgmann, Sahar Maleki
AAM will be attending and/or participating in the following industry conferences.
VCIA (Vermont Captive Insurance Association) Annual Conference
South Burlington, VT
(AAM Attending and Exhibiting)
August 13 - 15, 2013
Carolinas IASA Chapter Meeting
Myrtle Beach, SC
(AAM Platinum Sponsor, Attending, Exhibiting, and Speaking)
August 14 - 16, 2013
NABRICO (National Association of Bar Related Insurance Companies) Conference
(AAM Sponsoring and Attending)
August 14 - 16, 2013
BCBS Association Treasury Management Meeting
September 5 - 6, 2013
PCI Investment Seminar
Napa Valley, CA
(AAM Silver Sponsor and Attending)
September 8 - 11, 2013
NALC Fall Conference
Jackson Hole, WY
(AAM Attending and Speaking)
September 18 - 20, 2013
ACLI Senior Investment Managers Seminar (SIMS)
New Orleans, LA
October 20 - 23, 2013
ACLI Annual Conference
New Orleans, LA
(AAM Sponsoring, Attending, and Exhibiting)
October 27 - 29, 2013
If you have any comments about how we can improve the AAM Quarterly Newsletter, please let us know at: email@example.com
For more information about AAM or any of the information in the AAM Newsletter, please contact:
Colin Dowdall, CFA, Director of Marketing and Business Development
John Olvany, Vice President of Business Development
Neelm Hameer, Vice President of Business Development
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns.
This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.