FPA New Income Fund q2 shareholder letter below.
As a result of the slowing single family mortgage prepayment expectations resulting from rising mortgage rates during the quarter and the purchases above, the characteristics of the portfolio changed with both the effective duration and the yield-to worst increasing. These metrics continue to be within the targeted range of 2% to2.5% for the yield to worst and 1.0 to 2.5 years for the effective duration. By staying within these tolerances we are striving to help the portfolio continue to generate a positive absolute return in a twelve month period.
The overall sell off in the bond market last quarter had its biggest negative impact on the portfolio’s single family mortgage holdings. The majority of underperformance came from the Collateralized Mortgage Obligation (CMO) sequential and support structures and the mortgage pool holdings. In the case of the CMOs the primary reason for the negative returns for the quarter was an increase in the average life of the bonds due to an expectation of slower refinance activity within the underlying mortgage loans.
Those bonds backed by 15 year mortgages exhibited much less of a poor return versus the small allocation to jumbo 30 year mortgages. The portfolio owns mortgage pools representing mortgages that consist of 10 and 15 year amortization mortgages. In each case the negative return from these holdings was less than that experienced by the overall mortgage portion of the bond market. The Federal Reserve’s comments about potential “tapering” or reducing their purchase rate of securities had a dramatic impact on 30 years mortgages, which represent the bulk of the Federal Reserve’s mortgage purchases and holdings. Our view has been to position the mortgage portion of the portfolio in areas of the market that are being less impacted by the Fed’s purchasing program. That tactic has paid off for the portfolio.