At this point we are all aware of the global events that are unfolding, predominately due to the coronavirus. As a first priority we hope for everyone’s health and safety. The well-being of family and society cannot be understated as we all hunker down and hope for a resolution as soon as possible.
During this time, we wanted to send you a note regarding investments and the stress being experienced in the global markets. Over the past two weeks, the investment world has experienced a “1 - 2” knockout punch. Although there has been a lack of clarity surrounding the spreading of the coronavirus for more than a month, the oil price war announced last week triggered liquidity stress in almost all financial markets across fixed income, equities, currencies and commodities. The speed and violence of such price moves has been unprecedented. As just one example, yesterday’s equity market correction on Monday, March 16, was the worst day since the 1987 crash. Specific to the asset classes in which we invest, that is, corporate credit, preferreds, municipal bonds, and US Treasuries, there have been very few places, if any, to hide. Over a 24-hour period, just last week, we witnessed certain preferred issues drop 10 to 20% in price in one day. Many closed end funds and corporate bonds moved three standard deviations within a three-day period. For context, year to date, PFF (preferred ETF) is down -19.6%, HYG (US high yield corporate ETF) is down -13.6%, and LQD (US investment grade corporate ETF) is down -6.41%. We witnessed many municipal closed end funds move lower by 8% to 15% in price in one day and only briefly stabilize toward the end of last week. Even the treasury market last week experienced illiquidity. For example, look at the price performance of TLT (20yr US Treasury ETF), from last Monday to Friday's close which was lower by approximately -14%. Normally a 1 to 2% price move in any of these asset classes, ETFs, or indexes, is considered a large move and yet this past week we have seen 10-25% declines. What has been most challenging, is the fact that many fixed income traders and market-makers have been moved to offsite facilities and, more recently, home offices. This dislocation, combined with violent price action, has led to a lack of liquidity which we have not witnessed since the 2008 crisis. Although the US Federal Reserve, the Treasury department, and other central banks have acted with increased urgency and speed with policies and programs to guarantee liquidity, many investment markets have not stabilized.
As many investors know we entered this year in a fairly defensive stance with our long portfolios holding approximately 1/3 in cash and short-term treasuries. As we write this note, our liquidity position has increased to approximately 45% of our portfolios. We are confident in our security analysis and our process, as we believe these portfolios are very solvent. However, certain portions of our portfolio have experienced part of the dramatic above-mentioned price action in these various asset classes. The yields on our long portfolios have moved from approximately 3.5%-3.7% in January to over 5.6%, currently. If we were to deploy our liquidity at today’s prices, we could manage these portfolios with a significantly higher yield (between 7-8% yield at current prices); however, that would be at the risk of potential principal losses that would be hard to quantify and unacceptable at this time. Just to be clear, there is currently very good value in the credit markets with the preferred market close to 7% yield, US high yield approaching a 9% yield, and many municipal closed end funds yielding 5.5%. When prices and markets stabilize, we envision a significant total return on these portfolios even without allocating additional liquidity. In the weeks and months ahead we anticipate adding selectively, favoring higher quality securities that are priced at extreme discounts.
As the CIO of Bramshill, fortunately or unfortunately, I have been through the crises of 1998, 2001-2002, 2008, 2015-2016, and 4Q2018. Through each one of those periods, my teams and I came out profitable focusing on risk management and staying solvent. We all know there are no guarantees in the investment business, however we hope that history repeats itself here.
As we speak, our team is currently in risk management mode. During this period, we are: maintaining a significant amount of cash and short term treasuries in our portfolios, looking for any upgrades to make to our portfolios on a daily basis, reassessing all of our credit metrics and individual security structures, haircutting our probability of loss analysis, and being mindful of liquidity gaps. Although this sounds great and would be one of the highest yielding periods of our history of managing these portfolios, we are very mindful of price action over the next month as other investors could need liquidity and become forced sellers. Our view is that there will be a turn in the markets within the next four weeks, however we are not looking to be heroes today and would rather be patient.
There are two developments which will get us to deploy our liquidity in a quicker manner than described above. 1.) Meaningful clarity on the coronavirus. This may take the form of a significant slowing in the number of infections both in the United States and globally, progress being made on a vaccine or antidotes, or even the concept of warmer weather over time leading to fewer infections similar to flu season subsiding. We are not experts on viruses. Clearly, many developments could unfold and we hope they do so in a very positive manner. 2.) Prices of securities would need to move lower than even where they are in today’s market. Reassessing our targets of where we would feel comfortable deploying capital, in this very stressed economic environment, would entail quality investment grade corporate debt in the $80-$90 range, BB-rated high yield and higher quality financial preferreds in the $70 range, and investment grade municipal bonds yielding 5% or more. To be clear, we are not forecasting that prices will move to these levels. What we are saying is that we would be very comfortable weathering the severest storm at these levels given the variables of the economy, accommodative central banks, and our overall confidence in our investment process. Let me make a very key point here, similar to how we behaved in 2009, we are maintaining discipline around our liquidity and capitalizing only on opportunities where we see a very low drawdown probability.
Firm Operation and Business Continuity.
Many clients and business partners have been asking us questions which are appropriate given the current environment. As a firm, we have been prepared for disasters or unforeseen events. Not only do we have back-up facilities and perform an annual practice of “walk-throughs” of our entire firm operations from remote facilities, but every Bramshill employee is set up virtually at home with the same workstations and capability they have in our offices. We also have many service providers and business partners that shadow significant portions of our infrastructure and capabilities. Again, this is for protective measures to ensure against unforeseen events. For over three weeks now the Bramshill portfolio managers have been, more or less, separated. As of two weeks ago we closed all three of our offices. Our firm has been functioning virtually as one team unit. We have provided all of our employees with food allowances to prepare for an extended home stay in case such events and shortages were to unfold. Again, we hope that all of the current events are resolved as soon as possible. The health of our families, our employees, and our clients is paramount while we operate our firm and manage the capital of our investors. We wish everyone health and safety as we move forward.
Best, Art DeGaetano
Founder & CIO
Interested in more market insights from the Bramshill Team? Download our Q4 2019 Investor Letter here.
This commentary is provided by Bramshill Investments, LLC for information purposes only and may contain information that is not suitable for all investors. Certain views and opinions expressed herein are forward-looking and may not come to pass. Investing involves risk, including the potential loss of principal. Past performance may not be indicative of future results, which are subject to various market and economic factors. No statement is to be construed as an offer to sell or a solicitation of an offer to buy securities or the rendering of personalized investment advice. Stated performance is reflective of realized/unrealized capital gains/losses and investment income achieve in composite accounts, net of investment management fees and expenses for trading, custody and fund maintenance (where applicable). Returns reflect the reinvestment of dividends and other such distributions and performance for January 2009 through April 2012 depicts actual returns generated by the strategy while managed by the Firm’s Chief Investment Officer at an unaffiliated investment firm. All information is accurate as of the date of publication and is subject to change without notice.