ALL BONDS ARE NOT CREATED EQUAL by Matthew Pasts, CMT, CEO, BTS Asset Management, Inc. Bond sectors perform differently during periods of rising interest rates. Find Opportunity
ALL BONDS ARE NOT CREATED EQUAL by Matthew Pasts, CMT, CEO, BTS Asset Management, Inc. T here has been a long downward period for rates, and most investors expect this to change shortly. As we can see in the chart below, with rates going back to the late 1800s there are long periods of somewhat stable rates in addition to periods of rising or falling rates. Investors should be prepared to find opportunity whichever way the market may head. HISTORICALLY, THE END OF FED INTERVENTION IS BAD NEWS FOR TREASURIES 1951: Removal of Fed support for bond prices at the long end of the curve in 1951 sets off a 30 year bear market in bonds. 1994: Worst bond market rout since the Great Depression after Greenspan unexpectedly increases the federal funds rate. 2013: Uncertainty regarding the continuation of QE causes 10 year Treasury yields to rise 123 basis points over the summer. U.S. TREASURY YIELDS SINCE 1875 Source:Barclays, Guggenheim. Data as of 7.31.14
Just as many equities (e.g. growth, value, large, small, domestic, and international) and commodities (e.g. agricultural, minerals, energy, and gold) react differently to economic stimuli, bonds are also not all alike. Each bond class reacts in its own way to those stimuli. Interest rate changes are the primary, though not the only, factor affecting values of highly rated bonds, such as U.S. Treasuries and Investment Grade Corporate bonds. The bond market rarely moves in a straight line up or down. The values of lower rated bond classes may be significantly affected by business factors, and less so by interest rate changes. For a few bond asset classes interest rates are not the major risk. With High Yields it is mostly about default risk which ties them closely to the equity markets. BOND SECTOR RISK The correlation of High Yields to the S&P 500 and their negative correlation to Treasuries, confirms that High Yields act much more like stocks than they do Treasuries. 10 YEAR CORRELATION AS OF 6/30/15 1 BofA US HY Master II TR USD 2 Citi Treasury Benchmark 10 Yr USD 3 S&P 500 TR USD
No matter which macro trend plays out over time, the market s inability to move in a straight line highlights the need for tactical management. Many perceive the prior 30 year bull market in bonds circa 1981 as the great buy and hold opportunity that makes today s prospects far less appealing. Looking back, it may seem like easy street for those that sought capital preservation during a bull market in U.S. Government bonds. However, that bull market, like the bear before it, experienced extensive bursts of rising rate periods. The chart and table below illustrate periods where 10 year U.S. Government yields rose while falling long term. Even in the face of rising rates, High Yield bonds performed considerably better in these periods than U.S. Government bonds. There was nothing short term about these periods with each lasting a year or more and one lasted 3 years. These rising rate periods were strong and long enough to make any investor suspect the end of the bull market only to find yields soon after reconvening with its longer term downward trend. Prior to 1981, the same volatility composed the long term rise in yields. IT S NEVER A STRAIGHT LINE Source: 1 Bloomberg 2 Morningstar % Change 10 Year U.S. Government Yield 1 IA Barclays U.S. H.Y. Corporate Bond Index 2 Barclays U.S. Government Index TR 2 Oct 93 Nov 94 45.34% 0.05% 4.65% Oct 98 Jan 00 45.75% 6.30% 1.85% Jun 03 Jun 06 68.14% 28.18% 3.98% Dec 08 Jun 09 73.43% 30.43% 3.17%
Investors and advisors alike may be increasingly concerned about the effect that higher interest rates and expanding federal and municipal debt could have on medium and long term bond prices. Holding long term bonds in the years ahead may involve facing enduring volatility and loss of capital, especially at a time when investors may still be trying to recover from the market crash of 2008 09. The prospect of this happening has resulted in some investors keeping their money on the sidelines, unsure of what lies ahead. If interest rates eventually move higher, it seems plausible that monetary policy rates could return to a normalization level (closer to the average of 4% as opposed to today s 0 to.25%). Note that a zero rate Fed policy stance is unique in history and these types of events put us in uncharted territory. We may experience an unprecedented series of events in the years to come, a by product of our recent Great Recession, slow recovery and bear market in bonds. How then may advisors prepare for this and take advantage of differing performance of the various bond sectors for their clients in varying economic and market conditions? Today s environment calls for a tactical approach to bonds with the ability to move between bond asset classes based on market opportunities. The potential discrepancy in results among bond asset classes may be more pronounced than we have seen in the past 30 years. Which may create opportunity for a more tactical approach. BTS Asset Management s tactical, non traditional approach to managing traditional fixed income assets may help your clients regardless of what interest rates do in the future. With 35 years of tactical fixed income money management, BTS has the experience of managing through several market cycles, recessions, recoveries, and multiple up and down interest rate periods. Below is a chart on how the BTS Tactical Fixed Income Fund returned during four rising interest rate periods vs. the Barclays Aggregate Bond Index and the 10 Year Treasury. BTS TACTICAL FIXED INCOME FUND RETURN DURING PERIODS OF RISING INTEREST RATES
FUND PERFORMANCE AS OF 6/30/2015 The performance data quoted here represents past performance. Current performance may be lower or higher than the performance data quoted above. Investment return and principle value will fluctuate, so that shares, when redeemed, may be worth more or less than their original cost. Past performance is no guarantee of future results. A Fund s performance, especially for very short periods of time, should not be the sole factor in making your investment decisions. For performance information current to the most recent month end, please call toll free 1 877 287 9820. Total Expense Ratios: Class A: 2.08%; Class C: 2.83%; Class I: 1.83%; Class R: 2.33%. 1 The BTS Tactical Fixed Income Fund does not have performance as a mutual fund prior to May 31, 2013. Performance prior to May 31, 2013 shown above is for the Fund's predecessor limited liability company (BTS Tactical Fixed Income Fund LLC, formerly known as BTS Asset Allocation/High Yield Fund LLC). The prior performance is net of management fees and other expenses. The predecessor limited liability company had been managed in the same style and by the same portfolio manager since the predecessor limited liability company's inception on January 1, 2000. The Fund's investment goals, policies, guidelines and restrictions are, in all material respects, equivalent to the predecessor limited liability company's investment goals, policies, guidelines and restrictions. The following information shows the predecessor limited liability company's annual returns and long term performance reflecting the actual fees and expenses that were charged when the Fund was a limited liability company. From its inception on January 1, 2000 through the date of the prospectus, the predecessor limited liability company was not subject to certain investment restrictions, diversification requirements and other restrictions of the 1940 Act, which if they had been applicable, might have adversely affected its performance. In addition, the predecessor limited liability company was not subject to sales loads that would have adversely affected performance. The predecessor limited liability company s past performance is not necessarily an indication of how the BTS Tactical Fixed Income Fund will perform in the future. 2 Performance for periods less than one year are not annualized. There is no assurance that the Fund will achieve its investment objective. Barclays Capital Aggregate Bond Index is comprised of government securities, mortgage backed securities, asset backed securities and corporate securities with maturities of one year or more to simulate the universe of bonds in the market. Barclays U.S. Municipal Bond Index is composed of approximately 1,100 bonds; 60% of which are revenue bonds and 40% of which are state government obligations. S&P 500 includes 500 leading companies in leading industries of the U.S. economy and is a proxy for the total stock market. Municipals: Barclays Capital 10 Year Municipal Bond Index is comprised of investment grade tax exempt bonds with maturities between eight and twelve years. High Yield: Barclays Capital High Yield Index measures the of USD denominated, high yield, fixed rate corporate bond market. BofAML US HY II TR USD The Merrill Lynch US High Yield Master II Index is an index of high yield corporate bonds designed to measure the broad high yield market Barclays U.S. Government Index TR An index that is comprised of U.S. Treasuries with maturities of more than one year and U.S. agency debentures.
Investment Grade Corporate The U.S. Corporate Index is a broad based benchmark that measures the investment grade, U.S. dollar denominated, fixed rate, taxable corporate bond market. It includes USD denominated securities publicly issued by U.S. and non U.S. industrial, utility, and financial issuers that meet specified maturity, liquidity, and quality requirements. Each of these asset classes has its own set of investment characteristics and risks and investors should consider these risks carefully prior to making any investments. Investors cannot directly invest in an index and unmanaged index returns do not reflect any fees, expenses, or sales charges. Cumulative Return is the total gain, expressed as a percentage of the initial value. Correlation measures how two securities move in relation to one another. The use of Credit Default Swaps involves investment techniques and risks different from those associated with ordinary portfolio security transactions, such as potentially heightened counterparty, concentration and exposure risks. There is a risk that issuers and counterparties will not make payments on securities and other investments held by the Fund, resulting in losses to the Fund. The Fund may invest in derivatives. Even a small investment in options may give rise to leverage risk, and can have a significant impact on the Fund s performance. Derivatives are subject to credit risk and liquidity risk. The values of foreign investments may be affected by changes in exchange control regulations, application of foreign tax laws changes in governmental administration or economic or monetary policy or changed circumstances in dealings between nations. In addition to the risks generally associated with investing in securities of foreign companies, countries with emerging markets also may have relatively unstable governments, social and legal systems that do not protect shareholders, economies based on only a few industries, and securities markets that trade a small number of issues. The Fund invests in fixed income securities, derivatives on fixed income securities or Underlying Funds that invest in fixed income securities. The value of the Fund will fluctuate with changes in interest rates. Defaults by fixed income issuers in which the Fund invests could also harm performance. Lower quality bonds known as high yield or junk bonds, present greater risk than bonds of higher quality, including an increased risk of default. An economic downturn or period of rising interest rates could adversely affect the market for these bonds and reduce the Fund s ability to sell its bonds. The lack of a liquid market for these bonds could decrease the Fund s share price. The use of leverage by the Fund or an Underlying Fund will indirectly cause the Fund to incur additional expenses and magnify the Fund's gains or losses. The Fund may engage in short selling activities which are significantly different from the investment activities commonly associated with conservative fixed income funds. Underlying Funds are subject to investment advisory and other expenses, which will be indirectly paid by the Fund. As a result, your cost of investing in the Fund will be higher than the cost of investing directly in the Underlying Funds. Investors should carefully consider the investment objectives. risks, charges, and expenses of the BTS Tactical Fixed Income Fund. This and other information about the Fund is contained in the prospectus and should be read carefully before investing. The prospectus can be obtained on our web site, www.btsfunds.com, by calling toll free 1 877 287 9820 (1 877 BTS 9820), or by calling your financial representative. The BTS Tactical Fixed Income Fund is distributed by Northern Lights Distributors, LLC, Member FINRA/SIPC. BTS Asset Management, Inc. is not affiliated with Northern Lights Distributors, LLC. FOR PROFESSIONAL USE ONLY August 2015, by BTS Asset Management, Lexington, MA 02420. All rights reserved. Any dissemination, distribution, or copying of this document is prohibited.
About BTS Asset Management Founded in 1979, BTS Asset Management is one of the oldest risk managers, managing traditional assets with a nontraditional approach. BTS has a multi year track record in tactical fixed income and equity management. Our goal is to find opportunities with the potential to take advantage of rising markets while working to manage losses during downturns. BTS: Seeks to preserve capital Aims to offer downside protection and upside potential Strives to reduce volatility while delivering consistent long term returns FIND OPPORTUNITY BTS Asset Management 420 Bedford Street, Suite 340 Lexington, Massachusetts 02420 800 343 3040 www.btsmanagement.com 2435-NLD-8/6/2015