Despite COVID-19 the U.S. equity markets moved higher during the third quarter. The presence of government stimulus, the prospects for a vaccine, and expectation of additional stimulus, continued to provide a positive environment for equities. More recently the equity markets have become outright jubilant in response very positive vaccine news.
While the vaccine and stimulus news continue to be front and center, by far the most important news of the third quarter was the Federal Reserve Bank’s announcement regarding its policy change toward interest rates. In years past the Fed’s interest rate policy was guided by an effort to control inflation. The new mandate sets this aside and establishes a policy that emphasizes reaching full employment and allowing inflation to rise above levels previously considered too high. All this designed to drive higher economic growth. In summary, the Fed articulated a position of very low interest rates for a very long-time.
The implications for fixed income investors are negative, but for equities and real estate we believe it is a positive. As the Fed’s new policy takes hold and interest rates remain low, fixed income investors will be faced with a limited investment opportunity. Ultimately, we believe bond investors will be forced into higher yielding equities (stocks with stable dividends) and real estate that delivers higher returns vs. bonds. The change in Fed policy was sudden and we believe the implications will play out over many years.
We have stated in recent updates that fixed income investing has and will continue to be challenging. We believe the bar for adding new bonds is now much higher and we are working hard to find new avenues to deploy capital where we do not compromise on risk and are still able to generate attractive returns.
Our equity portfolios continued to deliver strong returns since the market bottom on March 23rd and on average have appreciated +67% since then. Year-to-date returns through October 30th on average for equity portfolios is -3.1%
As 2020 wore on investors continued their infatuation with all things technology. The technology sector of the US equity markets have dramatically outperformed everything else, carrying equity markets close to all-time highs. Our equity portfolios have joined this broad market advance, with technology holdings assisting in our portfolio’s recovery.
We expect post-election market volatility to continue. We are prepared to take advantage of this volatility should it reach extreme levels.
We did not add any new positions to the portfolio during Q3 2020.
Fixed Income Update
During Q3 2020 our corporate fixed income portfolios continued to recover from March 2020 lows. We continue have difficulty finding new opportunities to deploy capital as evidenced by the addition of one new fixed income position during Q3 2020. The message from Q2 2020 continues – “the landscape for fixed income investors is challenging. With elevated prices where they are today, and the associated ultra-low yields, we do not expect to make any additional bond purchases going forward”
We believe that on an after inflation and after fee basis owning fixed income is a poor use of capital. We will maintain our existing bond portfolio until our positions are either called away or mature. When, or if, the environment changes to where we believe a reasonable return is available, we will once again purchase fixed income.
Through October 30, 2020 our taxable fixed income portfolios on average have produced a -5.1% return. Our bond portfolio continues to recover along with the equity markets. However, as stated last quarter, our exposure to a handful of cyclical bonds (specifically energy) has impacted year-to-date performance. We continue to expect our non-energy fixed income holdings to recover as the economy improves. Today, our corporate bond portfolio has a yield to maturity of 3.87% with an average maturity of 3.30 years.
The returns available in the municipal market are even less attractive with bonds trading at 1.5% – 2.0% yield to maturity. We do not expect to add new municipal bonds to our portfolios.
We completed one new real estate investment in Q3 2020 in Atlanta.
Our real portfolio continues to deliver results consistent with our underwriting expectations. To date we have seen no material impacts to performance. We remain guarded about the future and will exhale once we see the economy functioning without eviction moratoriums and without high levels of government stimulus. Based on the performance of our properties year-to-date we do not expect to see any permanent impairment to any of our real estate holdings.
A more detailed description and update can be found in the “Real Estate Update” included with this letter.
We did not make any new private equity investment in Q2 2020
A detailed update on our current holdings can be found in the “Private Equity Update” included with this letter.
We remain focused on seeking out high quality investment opportunities and deploying capital when successful. Our pipeline of opportunities continues to fill up and we look forward to sharing more with you in the coming months.
Stay safe and be well.