FPA New Income, Inc. webcast audio, transcript & slides for the third quarter ended September 30, 2015.
FPA New Income 3Q15 Webcast Audio
FPA New Income 3Q15 Webcast Transcript
Tom Atteberry: What I’m looking to cover today is we’re sort of going to take a look at the portfolio’s attributes and how we think it might fit into someone’s overall fixed income allocation, sort of an update on the macro prudential/regulatory world, a look at our portfolio characteristics, some portfolio attribution, and then take a little bit of a deeper look into the credit portion of the portfolio and how we sort of evaluate an idea. And then as always we will close with questions and answers.
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First off, as we start let’s get a grounding of what we’re trying to accomplish. The first thing is we’re seeking to get an absolute return in a 12-month period, and then over a longer term we’re attempting to get CPI plus 100 over a rolling five-year period. When you look at those two objectives that we have, then the third thing becomes pretty simple. We are indifferent to the benchmark because we are trying to just solve for that equation of those two objectives.
You look at what we do… we’re much more security-driven, much less macroeconomic-driven. We are value investors like the other strategies here at FPA, and this is something where both securities and the portfolio are strenuously… we will stress them to figure out when things don’t work. We have a series of restrictions that are designed to control the risk of the portfolio such as a minimum of 75% of the assets will be double-A or higher, and we control things such as more aggressive or higher risk securities such as interest-only and principal-only securities. And then we don’t do options and futures. We’re not shorting. We don’t use leverage or those elements as well. And you can see the other ones on that page.
So one of the things that we look at when we’re evaluating the high quality portion of the portfolio is we realize that in a high quality portion of the portfolio everything in there is homogeneous in nature. It’s sort of driven by fiscal policy, monetary policy, direction of interest rates. We also know that you’re making asymmetric investments when you’re making bond investments. That is, we already know what our upside is. It’s the yield to maturity. If we own it till it matures, we get paid our principal back; we get paid our interest payments. That’s our return. What was the unknown for us is the downside risk. That’s the component we don’t know.
What was in the high quality component of the portfolio… it’s really not: are you going to pay me back. It’s the impact of changes and interest rates. And we’ve looked through history and realized that anywhere along a yield curve, whether it’s the two-year or the 30-year, to witness 100 basis point or 1 percentage point change in interest rates over a 12-month period’s not that unusual. But since we already know what our upside is, if we want to understand the downside, we go well what happens if we a 100 basis point increase in rates?
And the chart on this page illustrates and goes through that. The blue bars represent the yield to maturity of Treasuries, whether they’re the two, the three, the five, the seven, the ten or the 30, and then there’s the analysis of what if rates went 100 basis points in a 12-month period. What would happen? What would our total return be?
So as an example, looking at the two-year, it’s 63 basis point yield at the end of the third quarter. If it went from a one-point… a 63 basis point yield to a 1.63% yield a year later and we sold it, what would be our total return? We’d lose 34 basis points. So what that is indicating to us is you don’t have a margin of safety. You’re not getting paid for that risk occurring. This is how we look at everything within the high quality space, keeping in mind that we also may have to look at prepayment speeds and we may look at some spread data as well. But this is the main component and is that foundation for the duration management of the portfolio.
So how does this impact and manifest itself in the portfolio characteristics? The chart in the middle is showing you the FPA New Income Fund, the Barclays 1–3 Year Aggregate Index, and the Aggregate Index itself. And we just put up the duration of the yield-to-worst for each one of those three. And then the third column is just a very quick instantaneous look at: all right, if I take the yield-to-worst and I divide the duration into it, I will come up with an answer that tells me on an instantaneous basis how far do interest rates have to rise before I just get to a zero return. So in the case of us, it’s rough 196 basis points. For a 1–3 Year Aggregate Index, it’s about 53.
If I move forward and get a little more depth, we can do sort of a stress test to say: okay, if rates rise by 100, what might the return tend to look like? What direction could it be? And that’s what the equation is at the bottom. So walking through the equation for us, so we have a yield-to-worst of 2.79%. So one plus the yield-to-worst would be 3.79%. I add those two together; I get 6.58. I divide that by two; I get 3.29. I then subtract the duration from it, 1.42, and that’s how you get to the 1.87. It is giving you an indication that, if you saw a 100 basis point increase in yields and nothing else occurred in the portfolio—you didn’t change average lives, you didn’t have any contributions or withdrawals, spreads didn’t change, all those sorts of issues, just purely interest rate, and you didn’t take into account these—your return might look something like 1.8-something percent. Do that for the two indices; they both come out negative. So when we look at this, we realize, okay, this is what is driving us to construct a portfolio producing the positive return. We look at this and realize the indices actually are producing a negative return in that kind of environment.
So moving forward, this is a look over the last ten years, and this is looking at the five largest draw-downs using the Barclays Aggregate Index as sort of the center point of what we’re going to do. And how does the previous page sort of impact into draw-downs, the biggest ones you have? Well, the first thing you notice over the last ten years… three of the five have happened since 2008. One of them was during 2008, and you only had one prior to that. And in each and every case with the exception of May ’13 through August of 2013, our draw-down is less than not only the 1–3 Year Agg, but the Agg itself in a nontraditional bond fund category, which we find ourselves housed in at Morningstar. Only in that May period of ’13 did we go down by more; the other times, much, much less than any of the others.
If we move forward and think about maybe standard deviation as a way to sort of look at volatility and sort of try to measure some risk, what we’ve constructed here is a one-year period of standard deviation of movement. 9/30 is our ending date so we just did that for 2015, ’14, ’13, ’12, and ’11. And when you look through this same set of categories, you realize our standard deviation in 2011 and ’12 is lower than any of the others. The nontraditional is less than the Agg at times, but it tends to have an upward slope. In 2014 and 2013, during those periods, the 1–3 Aggregate Index actually had a lower standard deviation than we did. But when you compare it with the Agg or the nontraditional funds, we still are significantly less. So we’re still producing what we think is a low volatility type of return for the investments that we’re making.
See full transcript below.