Download Credit

Finding Opportunities in Difficult Markets
November 21, 2014
Hancock Institutional Advisors, LLC
SEC Registered Investment Advisor
Nick Trentmann, Portfolio Manager
Jeff Holley, Portfolio Manager
Hancock Securities Group, LLC
Member FINRA, SIPC, MSRB
Hancock Institutional Advisors, LLC
SEC Registered Investment Advisor
Hancock Management Services, LLC
Confidential and Proprietary
383 Marshall Avenue
St. Louis, MO 63119
(314) 997-3191 (tel)
(314) 997-3358 (fax)
1
www.hsg-hia.com
Employment Outlook
• Change in Nonfarm hiring was 214,000 in October and August was revised up from 180,000 to 203,000
• The last 9 months above 200k
• Service sector again made up the majority of hiring
2
Employment Outlook
• October Unemployment Rate fell to 5.8% from 5.9%
• Labor Participation Rate was up slightly to 62.8%
• Despite jobs dashboard, Fed still focuses most heavily on Unemployment Rate
3
Lack of Inflationary Pressure
• Fed is willing to accept 2.5% inflation (measured by Core PCE)
• October Core PCE was 1.5%
• Without wage gains inflation will struggle to take hold
4
Gross Domestic Product
• Annualized GDP growth was 3.5% in the third quarter
• Biggest surprise: 1.7% drop in imports and 7.8% rise in exports
• Net exports added 1.32% to GDP
5
Dollar Strengthening
• Dollar continues to strengthen versus major currencies
• Why a stronger dollar?
6
Oil Prices
• If the Fed tightens sooner than expected, growth will be muted, leading to weaker oil demand
• Saudi Arabia is resisting OPEC output cuts for fear higher prices will encourage more U.S. production
• Lower oil prices may aid consumer spending
7
Treasury Rates
• 10-year Treasury rate started the year at 3.0%, currently at 2.33%
• Fed ended QE program, and the markets’ focus has shifted towards tightening
• Rates will remain depressed as economy struggles to reach “Escape Velocity”
8
Themes from 2014
•
Rates are extremely low.
•
Very active Fed.
•
Market expects funds locked at 0.25% until 2015.
•
Yield curve will steepen before Fed Funds rise.
•
Cash flow over the next two years not helpful.
•
Avoid tail risk.
•
Some increase in optionality is acceptable.
•
Avoid decisions today that limit options in the future.
•
The longer we stay at low rates, the greater the risks become to rising rates.
•
Look at the portfolio as a whole, not just individual bonds.
9
Themes from 2014
What didn’t work?
–
–
–
Long-Dated Step-Ups
Multi-call Options with Long Maturities
Mortgage Backed Securities
What worked?
–
–
–
Floating Rate Structures
Credit (Corporate)
One-Time Call Options with Mid-Maturities
10
Defensive Bonds
Floating Rate Securities
–
–
–
–
Federal Family Education Loan Program (FFELP)
Corporate Floaters
Home Equity Conversion Mortgage (HECM)
Collateralized Loan Obligation (CLO)
5- to 10-Year Part of the Curve
–
–
–
Picks up income versus floaters
Rolls the curve
Risk: underperforms if an aggressive rise in rates
11
Four Ways to Increase Income
1. Credit
2. Liquidity
3. Optionality (Cash Flow Volatility)
4. Maturity
12
Fixed Rate Investment Options
Credit
Corporates
Municipals
Structured Notes
Typically
Investment Grade
GO Unlimited / Limited
US Sovereign
Credit Rating
(BBB- or better)
Liquidity
Optionality
Maturity
Highly Liquid
Bid /Ask: 3 – 5 bps
Essential Service Revenue
Depends on Issue
Highly Liquid
Bid / Ask: 2 – 3 bps
None
Can be callable
Callable
5 – 10 years
7 – 15 years
Varies
Please note that the characteristics provided above are typical of what our team sees in the market.
13
Floating Rate Investment Options
Credit
Liquidity
Optionality
Maturity
FFELP
CLOs
U.S. Sovereign
Credit Rating
AAA
Depends on Issue
Depends on Issue
Depends on Issue
Cash Flow
Cash Flow
Cash Flow
Final Maturity:
20 – 30 years
Final Maturity:
15 years
Final Maturity:
50 years
Average Life:
8+ Years
Average Life:
6 Years
Average Life:
7 – 8 Years
Please note that the characteristics provided above are typical of what our team sees in the market.
HECM
US Sovereign
Credit Rating
14
Whole Loans
Single Family Owner Occupied
5 / 1 Hybrid ARM
7 / 1 Hybrid ARM
15 Year
HELOC
Yes
Yes
Yes
Yes
Historical Loss Experience
< 25 bps
< 25 bps
< 25 bps
Yes, but very
originator dependent
Servicing
Released
Released
Released
Retained
Limited
Limited
Limited
Limited
Time to Sale
120 – 180 days
120 – 180 days
120 – 180 days
120 – 180 days
Costs to Sell
50 bps
50 bps
50 bps
50 bps
125-150 bps over like
duration Treasury
150 -170 bps over like
duration Treasury
Prime
No
No
No
No
Various
Various
N/A
Prime
225
225
N/A
Various
Caps
2/2/5
2/2/5
N/A
Various
Floors
Sometimes
Sometimes
N/A
Various
Credit
Established Industry Credit Criteria
Liquidity
Unlimited / Limited
Spread
Priced to:
Prepayment Penalty
125-150 bps over like
duration Treasury
ARM portion:
Index
Margin
Please note that the characteristics provided above are typical of what our team sees in the market.
15
Whole Loans
Commercial
Multi-Family
CRE Other
Established Industry Credit Criteria
Yes
Yes
Historical Loss Experience
Yes
Yes
Unlimited / Limited
Limited
Limited
Time to Sale
180 days
180 days
Costs to Sell
50 bps
50 bps
200 bps
250
Yes
Yes
LIBOR
LIBOR
275
275
1% annual
1% annual
6% life
6% life
Credit
Liquidity
Spread
Fixed Period Initial Spread to Treasury
Prepayment Penalty
ARM portion:
Index
Margin
Caps
Please note that the characteristics provided above are typical of what our team sees in the market.
16
Takeaways
1. Greatest spread remain in corporate issues
2. Reduce amount of cash flows in less than 2 years
3. Yield curve is attractive in the 5- to 10-year sector
4. Rates in the 5- to 10-year part of the curve have room to fall
5. Fed purchases/reduced volume = MBS spreads to remain tight
6. Roll of curve is attractive
17
Current State of Equity Markets
• U.S. equities rose for the 7th straight quarter as the S&P 500 closed up 1.13%.
• International and emerging market equities fell 4% as Japan, China and Europe deal with slower economic growth and
deflation fears.
18
Current State of Equity Markets
• Geopolitical tension and Ebola fears caused volatility to creep back into the markets.
• As has been the case for the last 2 years, investors quickly bought the dip, and order was quickly restored.
19
Current State of Equity Markets
• Equity performance has been highly correlated to Central Bank intervention
• This includes actions by the European Central Bank, Bank of Japan, Bank of England and others.
20
Equity Outlook
Source: Standard & Poor’s, Robert Shiller Data, FRB, FactSet, J.P. Morgan Asset Management.
• Equities currently look fairly valued. Earnings growth has been fueled primarily by financial engineering (stock
buybacks, margin expansion and M&A activity) and not sales growth.
• Equity prices will move in tandem with earnings growth and not multiple expansion.
• Strong economic growth is needed for continued 10%+ returns. We would view a 10%+ correction as healthy and
would look to add.
21
Equity Outlook
Source: Standard & Poor’s, FactSet, Robert Shiller Data, J.P. Morgan Asset Management.
• Relative to bonds, equities look attractive.
• Current S&P 500 yield is roughly 1.791% compared to the 10-year at roughly 2.35%.
• Historically around 5%, current S&P 500 dividend growth rate per year is currently at 11.89% (YTD).
22
Current State of Equity Markets
Normalized P/E Russell 2,000
Source: Russell Investment Group
• Small-cap equities continued to underperform. They were down 7.36% for the quarter and have underperformed
large-cap stocks by 15% in the last 12 months. Despite this underperformance, they still remain about 30% over
fair value relative to large-cap stocks.
• We expect small cap stocks to stay under pressure as investors remain cautious about this rally and sell riskier
assets in favor of perceived safe havens like large cap stocks, bonds and cash.
23
Equity Outlook
Source: Standard & Poor’s, Russell Investment Group, FactSet, J.P. Morgan Asset Management.
• Favor growth over value and opportunistic value names.
24
Equity Outlook
Source: Standard & Poor’s, Russell Investment Group, FactSet, J.P. Morgan Asset Management.
• We currently favor the health care, information technology and energy names.
• Falling oil prices have made consumer staples and discretionary names more attractive.
• Financials will benefit from rising rates. Regulatory pressures and other added costs will continue to hinder
earnings growth potential.
25
Equity Outlook
• Consider an allocation to international equities (5 – 15%, based on the portfolio)
• Valuations gap will close in the coming years if Europe can turn the corner and China can stay on stable ground
and convert to a consumption-driven economy.
• As of December 31, 2013, there were 631 companies outside of the U.S. with a dividend yield of at least 3%. Only
99 such companies exist in the U.S.
26
Portfolio Positioning
• Stick with U.S. large cap dividend paying equities, specifically companies with strong balance sheets.
• Increase allocation to alternative money managers – long/short equity, buy-write strategies and event driven
funds.
• For international stocks, look for experienced active managers with long term, multi cycle experience. Value focus
with ability to add to positions in volatile markets.
27
Biographies and Disclaimer
Nick J. Trentmann, Portfolio Manager
At Hancock Institutional Advisors, LLC, Nick is responsible for portfolio and securities management and analytics for fixed income
portfolios. He also assists in the firm’s sales and marketing efforts to institutional clients. Prior to joining Hancock in 2007, Nick was a
financial advisor with Renaissance Financial and a credit analyst at Citi. Nick brings ten years experience in the financial services
industry. Nick earned a bachelor’s degree from the University of Missouri. He holds Series 7 and 66 licenses from FINRA.
Jeffrey R. Holley, Financial Advisor & Portfolio Manager
At Hancock, Jeff Holley works alongside clients to help identify and achieve their financial goals. He conducts and distributes
investment research throughout the firm, is a co-manager of the Conservative Equity Strategy, and serves on Hancock’s Investment
Committee. In addition to his advisory-based roles, Jeff executes trades, maintains option orders, monitors the overall client allocation
process, and writes investment commentary on behalf of the firm. Prior to joining Hancock in 2013, Jeff worked at Edward Jones where
he most recently served as an Equities Investment Specialist, primarily involved in conducting research and providing solutions to
Financial Advisors. Jeff earned a Bachelor of Science degree in Business Administration from the University of Missouri - Columbia. He
holds Series 7 and 66 licenses from FINRA and is currently a Level II candidate in the CFA program. Jeff is an active member of Marian
Middle School’s Young Friends Committee and Finance Committee.
For copies of this presentation, please contact Nick at (314) 997-3191 x315 or [email protected].
The material contained herein has been prepared from sources we believe to be reliable, but is provided without any representation as to accuracy or completeness.
This material does not purport to be a complete analysis of the securities, companies or industries involved. This material is published solely for informational
purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. All opinions and estimates included with
this material are our own unless otherwise stated and are subject to change without notice. All investments can fluctuate in price, value and/or income. Past
performance is not necessarily a guide to future performance. This material has no regard to the specific investment objectives, financial situation or particular
needs of any specific recipient.
28