Holding firm to value investing amid a turbulent fixed income climate | Fixed Income market commentary 3Q23
Oakmark is the mutual fund family launched in 1991 by Harris Associates, the Chicago deep-value firm founded in 1976 (about $105bn AUM). Bill Nygren runs the flagship Oakmark Fund and David Herro the Oakmark International Fund, buying businesses at large discounts to intrinsic value and holding them like owners — publishing quarterly fund commentaries, market commentaries and insight articles.
In plain words
This report says bonds have fallen so much that many investors are panicking and switching to cash. But it argues the opposite: U.S. Treasuries and high-quality corporate bonds now offer over 2% annual return after inflation—something not seen in the past decade. For the average person, buying bonds now could be smarter than holding cash, but only if you’re willing to wait years for the payoff, not days.
Oakmark’s third-quarter 2023 fixed income market commentary notes that although the current environment is shaped by the Federal Reserve’s rate hiking cycle initiated nearly two years ago, and the fixed income market is experiencing its worst sell-off since the 1970s, with short-term volatility and
Theme and Background
This chapter discusses how value investing principles can be applied to bond investments amid the significant sell-off in the fixed-income market triggered by the Federal Reserve's rate hike cycle. Current market sentiment is dominated by short-term variables (such as supply imbalances, new bond issuance, and the Fed's dot plot), with widespread panic. However, the report argues that this precisely creates opportunities for long-term value investors.
Core Thesis
The report's central judgment is that the long-term value of U.S. Treasuries and high-quality corporate bonds now exceeds any period over the past decade. This view stands in stark opposition to the prevailing market panic (selling off, shifting to cash). The report emphasizes that the essence of value investing is not predicting short-term moves but buying when asset prices fall below intrinsic value, and current fixed-income assets are offering such a margin of safety.
Key Arguments and Data
- Real Yields: U.S. Treasuries now offer over 2% annualized real returns (inflation-adjusted) across every point on the duration curve, compared to negative average real returns over the past decade.
- Corporate Bond Yields: High-quality corporate bonds (with a historical default rate below 2%) offer inflation-adjusted yields exceeding 4%.
- Historical Comparison: The current sell-off is the most severe in fixed income since the 1970s, but the report believes this actually enhances long-term value.
Key Data Comparison Table:
| Indicator | Past Decade Average | Current Level |
|---|---|---|
| U.S. Treasury Real Yields | Negative | Over 2% (all maturities) |
| High-Quality Corporate Bond Inflation-Adjusted Yields | Not specified | Over 4% |
| High-Quality Corporate Bond Historical Default Rate | Below 2% | Below 2% |
Companies/Assets Involved
- U.S. Government Treasuries: The report is bullish, arguing that their real yields now offer an attractive margin of safety.
- High-Quality U.S. Corporate Bonds: The report is bullish, highlighting that their inflation-adjusted yields exceed 4% with a very low historical default rate.
- Cash: The report implies that the current panic-driven shift to cash is a mistake, as the long-term value of bonds is now undervalued.
Investment Implications
- Contrarian Action: Investors should ignore short-term panic (such as supply imbalances or QT effects) and use the current rise in yields to buy U.S. Treasuries and high-quality corporate bonds.
- Focus on Real Yields: Inflation-adjusted yields (over 2% for Treasuries, over 4% for corporate bonds) provide a sufficient margin of safety and serve as the core anchor for value investing.
- Avoid Chasing Short-Term Variables: The report explicitly opposes making decisions based on short-term factors like the Fed's dot plot or technical trading levels, advocating a return to fundamentals—namely, the intrinsic value of assets.