The buildup to and launch of a COVID-19 vaccine during the fourth quarter of 2020 led to record highs being set in the stock market and a steeper Treasury yield curve. The news of the vaccine also benefits spreads on investment-grade corporates and taxable municipals. These spreads continue to grind lower from their highs earlier this year as the economy rebounds and spreads approach pre-pandemic levels.
As the fourth quarter ends, the largest movement in Treasury yields is seen in the longer-maturity securities. The 10-year Treasury had experienced the biggest increase in yield as of 12/28/20, rising 26.6 bps to 0.951% for the quarter. That was followed closely by the 20-year and 30-year Treasuries which rose 26.3 bps to 1.488% and 24.1 bps to 1.698% respectively. The front end of the curve remained flat to slightly down in yield during the fourth quarter. The 1-year T-bill experienced the biggest decline in yield as it dropped 2.0 bps to 0.096% as of 12/28/20. This was in line with our expectation as the Fed continues to hold the fed funds rate at the 0–25% range and to signal that they expect to hold short-term rates lower for longer.
With the Fed holding short-term rates low and positivity growing for an end to the pandemic, resulting in a steeper yield curve, spreads on investment-grade corporates and taxable municipals continue to tighten. These tightening spreads benefited the performance of Cumberland’s Taxable Total Return Strategy, as we remain overweight in taxable municipals and corporates relative to our benchmark. As we have discussed in previous articles, at the end of the first quarter and throughout the second quarter we extended our durations to take advantage of spread widening as the pandemic hit the United States.
At their peaks, the Bloomberg Barclays US Agg Corporate Bond Index widened to +373 bps as of 3/23/20, and the Bloomberg Barclays Taxable Muni US Agg Index widened to +262 bps as of 3/25/20. Since reaching those highs, they have nearly returned to the pre-pandemic lows. The corporate index, as of 12/28/20, is at +100 bps, which is only 7 bps higher than it was on 12/31/19, when it was at +93 bps. The taxable muni index is down to +126 bps, which is only 22 bps higher than it was on 2/24/20, when it was at +104 bps. Increasing our weightings in these securities was the key driver in our performance and helped make up for underperformance when Treasury yields plummeted and spreads widened during the first quarter of 2020.
At the end of the third quarter and into the fourth quarter we started selling some of our longer maturities to take profits as we became a little more defensive. We are continuing to add more defensive securities to the portfolios, including Treasury floaters and T-bills, as we discussed at the end of the third quarter. We are also adding a weighting in short agency securities to get portfolio durations down and to protect the gains from longer securities that we sold to take advantage of the rally in spread securities.
Going into next year we will continue to take a conservative approach to investing portfolios in the current yield environment. Our expectation is that once we can put COVID-19 behind us we will continue to see the yield curve steepen. For that reason, we will continue to add defensive securities to portfolios while looking to take profits where we can in securities that have benefited from tighter spreads in a yield-starved market.
Daniel Himelberger
Portfolio Manager & Analyst – Fixed Income
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