What happened to the bond market earlier this year?
Basically, we ended up with a baby and bathwater situation. The equity market fell off between the end of February and the middle of March, and eventually, that bled over into the fixed income side. People got so sick of their equities being beaten up that they were running to cash, and it didn’t matter what they were selling. Within a stock, you can think of the price as a result of two forces pushing against each other. When you go to sell your Apple stock at $360 a share, there’s an equal force on the other side waiting to purchase. Well, it’s not always that way with bonds. In this particular instance, you had an enormous number of bondholders selling and a massive number of funds that were mandated to liquidate bonds due to mutual fund redemptions. Instead of having two equal forces pushing against each other, we had everyone pushing one way and no one the other side. As a result, we saw the cleanest, safest, highest priced securities in the markets losing all their value in a matter of hours, and it stayed that way for 3 or 4 days. Typically speaking, a clean AAA municipal bond will trade at about 90% of the treasury curve, and instead, we were buying bonds at 700%, 800%, even 1000% of treasuries. While the 10-year treasury was at roughly .7%, we were buying Massachusetts state general obligation AAA bonds, backed by the full taxation power of Massachusetts, at 6%. When you include the tax-equivalent yield, you’re looking at 10% annualized and tax-free for that bond’s life.
It was a tidal wave, and you could buy anything you wanted at any price because there was no one else buying. Something you would typically see trade at $120 or $130, you were picking up at par or at $95 a bond. It was an absolute surge of paper and everything, but treasuries sold off at an incredible pace, including corporates and preferreds. We were picking up the cleanest of the clean municipal bonds, with 10-15 year maturities at historically low prices. Then, the Fed came out and decided they were going to backstop the liquidity of the market. They reinstituted quantitative easing, dropped rates to zero, started buying corporate, municipal, and asset-backed paper to essentially become the other side of the two-force problem. That move gave everyone else an exit, and it stabilized prices. But the period between the 15th and the 23rd of March was the biggest bond meltdown in my career and certainly one of the biggest opportunities we’ve had for buying clean paper at ridiculous prices.
What were the factors that put Narwhal in a buying position during this time?
Maintaining asset allocations. During the run-up to the end of February, we’d actually been net sellers of equity in order to beef up fixed income. Supply was limited, so we were slow-moving into filling those bond portfolios and transitioning from equities to cash to fixed income. As a result, we had a little excess cash, and the defined maturity structure of the bonds we buy means that we constantly have money coming due to reinvest in new bonds. Using a ladder approach, we build a portfolio that slowly rolls towards maturity. Over time, we have bonds maturing so that we can reinvest to look for relative value to replace the old bonds in the ladder. When all the pieces fell into place and supply went from zero to infinite in a matter of days, we were able to act quickly because of our asset allocations.
What sets Narwhal apart when it comes to our fixed-income selection?
We have access to a number of municipal and corporate trading desks that gives us the same level of functionality as a high-level broker-dealer, so we can buy any bond we want. I’m in daily communication with several vendors of bonds, and because we’re large enough, we can negotiate prices and types of bonds that desks buy specifically for us, which nets us better prices and yields. The goal for our bond portfolios is to maximize the mundane. Traditionally, most people punt on fixed-income by going into a mutual fund and hoping to get 2%-3% a year. Narwhal wants to take that 40% of the portfolio and squeeze as much yield and performance out of it without sacrificing credit quality. We’re taking an allocation that most people punt on and maximizing the mundane. Sometimes, we are buying the same bonds as those funds, the difference is we charge less, we get the bonds at better prices, and we structure it according to your portfolio instead of just throwing you into a fund.
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