While the summer months are supposed to be a time to relax, the third quarter proved to be a stressful period for fixed income and pension managers. In August, the 10-year U.S. Treasury bond tested the lower bound of the 1.50%–3.00% range in which its yield has fluctuated since 2011 as concerns about global growth permeated the market. In addition, communications from the U.S. Federal Reserve’s July rate-setting meeting left investors wondering whether the central bank was committed to further easing. This drove spreads wider and rates lower, but the move in rates dominated and ultimately drove down pension plan discount rates even further.

U.S. long investment-grade bonds A volatile third quarter for bond yields

Option adjusted spread and yield to worst calculated for the Bloomberg Barclays Long U.S. Corporate Index as of September 30, 2019.
Sources: Bloomberg Index Services Ltd., Refinitiv Datastream. As of September 30, 2019

Our long credit portfolio continues to be underweight credit risk, which is driven both by valuations and the late-cycle timing. We continue to find reasonable relative value in consumer noncyclical companies. Our key holdings are in pharmaceutical, tobacco and food and beverage companies — particularly those that have engaged in transactions that have temporarily increased leverage. We also own positions in several energy companies that are dedicating free cash flow to reducing leverage. We own a larger-than-usual position in U.S. Treasury securities to balance the impact of credits with higher spreads on the portfolio and to maintain an overall credit position below that of the benchmark.

The portfolio rose in value for the quarter but trailed the index. Duration and curve positioning combined was the largest detractor from relative returns as the portfolio was slightly short duration while interest rates rallied in August. Sector selection also detracted, due largely to a position in a high-yield security that experienced spread widening on issuer-specific news. However, this was offset by an overall positive contribution from issuer selection that was driven by holdings in the consumer noncyclical and energy industries.