Speakers: Portfolio Managers Richard Duff & Michael Cheung

Market Recap:

The Barclays U.S. AGG in Q3 was down another 4.75%, almost the same amount as the S&P 500 in Q3. Currently the U.S. AGG YTD is down 15%.

This is partly driven by the reality that the Feds are raising rate quickly to match the inflation curve. Prior to 2008 the Fed funds rate was above CPI most of the time but since 2008 we have seen fed funds rates being below CPI.

The treasury yield curve through 2022 began normal then shifted up in a dramatic way, the short end of the curve has gone up a lot more than the long end of the curve. Bottom line is that this is a dramatic shift that leads to a significant change in economic activity and the cost of money. This year has been the greatest change in the 10yr yield since the 1960s.

There is a correlation conundrum that has created a real shift in market dynamic. Typically, when the S&P 500 is down 15% or greater the U.S. AGG is usually flat or positive and this year has not followed that trend at all.

The 60/40 made up of S&P 500 and U.S. AGG has surpassed the amount of loss it incurred in 2008 down -22.25%

The U.S. AGG total return has been negative since 2018.

The Global Aggregate Bond Indexes current drawdown is -24.5% which has wiped out a decade of gains even after collecting yields.

The large spike in mortgage rates, 30yr average mortgage rate is above 7%. There is a correlation between a decrease in home sales as mortgage rates increase.

Crude oil price has gone down and is just above 94 dollars a barrel.

From 1927-2022 the S&P 500 return 12 months after the peak of inflation has averaged 11.50%.

So far this year we have only given back 2 years of performance in the S&P 500 compared to 2020 was 3.3 years and 2009 was 12.5 years.

Portfolio review:

The only change that was made at the end of the quarter was in the dynamic strategic bond sub strategy. Which reduced long-term treasury exposure by 60%, eliminated TIPS and put the long-term treasury exposure into U.S. investment grade corporate bonds.

TIPS trade on expectations of inflation. They have a yield, and the underlying principle gets adjusted based on CPI.

There is an opportunity for par on investment grade corporate bonds due to the daily prices trading around 87 dollars maturing at par. Which creates an opportunity for the reversion to the mean as the bonds get closer to par. As prices go down on bonds the coupon stays the same and the duration of these different indices get shorter.

The U.S. AGG is trading at about 88.5 dollars still showing value in the portfolio, the model exposure remained the same.

Risk-off in all the tactical sub strategies and by design still risk on in the long only strategies. Approx. 58-58.5% defensive across all the portfolios. The tactical components are doing their job and behaving exactly how expected in a scenario like this.

End of year things to note:

Redwood is in the product construction process of putting together an alternative fixed income allocation that can be included in the models. The framework of a product where you know that the underlying collateral and the borrower credit worthiness. The key is certain type of structures in a private credit real estate-oriented solution where you can not have to take the marks and drawdowns along the way because you have the value in that security. We don’t have anything specific to share yet but that is coming, and we are excited to roll that out. Disclosure: Please see Redwood 10.12.2022 Partner Webinar for disclosures