Oakmark Bond Fund: Fourth Calendar Quarter 2023 Commentary

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MARKET OUTLOOK POSITIONING

Positioning

In 2024, we will focus on three key themes: credit selection, continuing our shift from historically overvalued asset classes to those that underperformed last year and remain undervalued, and monitoring how an economic slowdown might affect default risk. The current “spread,” the amount of excess yield offered by corporate bonds, continues to offer limited appeal for those seeking straightforward gains in the traditionally liquid segments of fixed income.

More specifically, our strategy for the coming year sounds a lot like the fourth quarter of 2023. It involves opportunistically transitioning from richer corporate credit to securitized credit, leveraged loans, and individual corporates that did not fully benefit from last year’s narrowing spreads. The indexes still exhibit significant variation at both the asset class and subsector security levels. This diversity reinforces our commitment to a selective investment approach, particularly in high-quality leveraged loans, non-agency securitized products, and certain areas within the high-yield and investment-grade sectors. In these areas, there are opportunities for strategic de-leveraging, even against a backdrop of a weakening macroeconomic environment.

Last year, we reduced our exposure to individual corporate credits, favoring securitized assets and high-quality duration instead. This year, we will likely continue this approach if current market valuations hold. We recognize that recent inflation data increases the likelihood that the Fed can lower interest rates without significantly disrupting the labor market, a scenario that could lead to even tighter credit spreads. However, we are also aware that the economy is expected to continue slowing in the first half of the year, and we believe that the Fed is unlikely to meet fairly aggressive current market rate forecasts, either in terms of timing or magnitude of cuts. Given the current valuations, we will continue to identify individual value in our selections and make focused bets where we see exceptions to the overall richness at the benchmark level.

Performance

In what could be characterized as an ideal environment for the Oakmark Bond Fund’s (MUTF:OAKCX) (“the Fund”) bottom-up focused, security-level portfolio construction, the Fund’s security selection and asset allocation decisions drove performance and resulted in significant outperformance compared to the Fund’s benchmark in both the fourth quarter of 2023 and calendar year 2023.

The Oakmark Bond Fund gained 7.14% in the fourth quarter of 2023, outperforming its benchmark, the Bloomberg U.S. Aggregate Index, by 32 basis points. For the calendar year ended December 31, 2023, the Oakmark Bond Fund returned 6.90%, besting its benchmark by 137 basis points.

Fourth quarter 2023

During the fourth quarter of 2023, yields declined significantly after the 10-year yield peaked around 5.00% in late October, and credit spreads contracted meaningfully as the market recalibrated its odds for a Fed-induced recession. The Fund’s fourth-quarter outperformance was driven by security selection and asset allocation decisions, although its slightly shorter duration profile than its benchmark was a slight headwind. Prudent security selection contributed approximately 48 basis points to the Fund’s outperformance in this quarter as corporate credit provided significant excess returns and asset-backed security (ABS) spread tightened. The securities that contributed most significantly to this quarter’s security selection were Cushman & Wakefield (CWK) 6.75% Secured Notes due 5/15/2028, Apollo Commercial Real Estate (ARI) 4.625% Secured Notes due 6/15/2029, and Ally Financial (ALLY) 4.7% Perpetual Preferred Bonds. In contrast, the FHLMC Multifamily Structured Pass Through due 10/25/2036, Anglo American (OTCQX:AAUKF, OTCQX:NGLOY) 3.875% Senior Unsecured Notes due 3/16/2029, and the ArcelorMittal (MT, OTCPK:AMSYF) 6.55% Senior Unsecured Notes due 11/29/2027 were the largest underperformers on a security selection basis.

Allocation decisions contributed positively to fourth-quarter performance. The strong excess returns in both corporate credit and structured securities were captured by the Oakmark Bond Fund’s overweight in both categories. These allocation decisions were the byproduct of our focus on risk-adjusted returns of individual securities across spread products, and the fourth quarter began with a reasonable amount of spread dispersion between credit asset classes, sectors, and ratings quality. The Fund maintains a higher proportion of corporate debt and securitized debt compared to the Bloomberg U.S. Aggregate Bond Index at 41% versus 26% and 34% versus 28%, respectively. The Fund’s allocation decisions accounted for approximately 39 basis points of outperformance versus the benchmark during the fourth quarter of 2023.

While security selection and allocation decisions resulted in outperformance during the fourth quarter, the Fund’s modestly shorter average duration relative to the benchmark was a headwind. The Fund extended its duration as real rates increased in the latter part of the second quarter and continued to do so early in the third quarter when yield increased. The quick and significant repricing of the yield curve in November and December caused long-duration assets to generate more returns. By the end of the quarter, the Fund held an overall duration of roughly 5.9 years in contrast to the benchmark’s duration of approximately 6.2 years.

Calendar 2023

The year began with historically attractive corporate spreads, very attractive valuations for structured products, and elevated rate volatility due to the Fed’s tightening cycle. This environment favored active managers, including the Oakmark Bond Fund’s bottom-up, research-driven strategy. As with the fourth-quarter returns, full-year returns were the result of security selection and asset allocation. The Fund returned 6.90% for the year and outperformed its benchmark by 1.37%.

Security selection accounted for approximately 68 basis points of outperformance versus the benchmark as corporate credit spreads and ABS spread contracted, and our securities outperformed the broader market. The positions that contributed most significantly to positive security selection were the Carvana Auto Receivables Trust Series due 01/10/2029, the Southern Company (SO) 3.75% Junior Subordinated Hybrids due 9/15/2051, and the Cushman & Wakefield 6.75% Secured Notes due 5/15/2028. Some positions lagged the benchmark, and that detracted from security selection during the year; these included SVB Financial Group (OTCPK:SIVBQ) 4.25% Perpetual Preferred bond, Signature Bank (OTCPK:SBNY) New York 4.0% Subordinated bond due 10/15/2030, and SVB Financial Group 4.0% Perpetual Preferred bond.

Asset allocation decisions were the largest driver of portfolio outperformance during 2023, accounting for approximately 139 basis points of outperformance. As mentioned above, the Fund’s asset allocation is a byproduct of expected risk-adjusted returns for individual securities, and as a result, the Fund was overweight in both corporate credit and structured products versus its benchmark.

The Fund’s duration positioning versus its benchmark was a modest headwind for the calendar year, detracting approximately 13 basis points of outperformance versus the Bloomberg U.S. Aggregate Bond Index. The Fund entered the year with a duration position that was meaningfully shorter than its benchmark and gradually adjusted that position to just short of its benchmark by year-end. With both five-year and ten-year real rates still attractive historically and Fed policy normalizing, this near-neutral stance aligns well with the environment as we enter 2024.

Connect with us

We value our relationship with our investors and welcome any questions or concerns. Please don’t hesitate to reach out to our team. We hold regular investor calls and meetings where you can interact with us and learn more about our strategies and future plans. You can also email us at aabbas@harrisassoc.com or mhudson@harrisassoc.com.

Adam D. Abbas, Portfolio Manager

M. Colin Hudson, CFA, Portfolio Manager

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