Strategic Enhanced Yield Fund Commentary
The Fund’s Investor share class returned 2.79% during the second quarter, compared with the Bloomberg Barclays U.S. Aggregate Bond Index1, which returned 3.08%.
How did the market’s fixed income sectors perform?
First-quarter gross domestic product1 growth came in at a surprisingly strong 3.1%, while forecasts for the second quarter point to a high 1%/low 2% range. As commodities cooled off in the second quarter, inflation expectations moved back down to the year’s lows. The decline in inflation expectations played a large part in forming the Federal Reserve Board's (the Fed) new dovish bias, with a near-term interest rate cut now very likely. Rate markets are currently pricing in two or more rate cuts over the remainder of 2019.
As the Fed furthered its dovish tilt and trade-war rhetoric died down, interest rates continued to decline and credit spreads contracted further in the second quarter. This perfect environment for fixed income allowed the Bloomberg Barclays U.S. Aggregate Bond Index1 to improve upon the strong first quarter, returning 3.08% in the second quarter, for an astounding 6.11% return in the first half of the year. The corporate bond sector was again the star performer, with the corporate1 portion of the index up 4.48% for the quarter and 9.85% year-to-date.
The commercial mortgage-backed securities1 (CMBS) portion of the index returned 3.28% and the agency1 MBS and Treasury1 components returned 1.96% and 3.01%. Lacking much duration or credit risk, the asset-backed securities1 (ABS) portion of the index was again the laggard, returning 1.67%. The 10-year Treasury1 yield fell 40 basis points (0.40%) during the quarter, ending at 2.01%. The declines were larger on the short end as the market priced in multiple rate cuts. The 5-year bond declined 47 basis points (0.47%) and the 2-year bond fell 51 basis points (0.51%).
What were your primary investment strategies during the quarter?
The Fund’s duration was equal to its index. It continues to have a heavy weighting to non-agency mortgage-backed securities and asset-backed securities. Within the securitized sector, we continue to focus on very seasoned, pre-crisis securities, though we have added significant exposure to newer issues. This sector performed well during the quarter.**
We have few corporate names in the portfolio and corporates did remarkably well again in the second quarter, so that was a large headwind for the Fund. We also maintained a high-quality bias in the second quarter. We do own junk bonds, but within that category we stayed at the high end of the spectrum. Lower-quality securities in general outperformed for the quarter, so our lack of exposure there also significantly weighed on relative performance.**
How did your strategies influence performance?
The Fund underperformed its index by 29 basis points (0.29%) in the first quarter. The underperformance was driven entirely by the underweight to corporates.**
How do you expect to position the Fund in the coming months?
Our expectation is that we are late in this economic cycle, so we are going to maintain a higher-quality bias while seeking to maintain significant liquidity. We will continue to focus on the non-agency securitized sector; we believe that higher-quality securities in this sector offer some of the best risk/return potential in fixed income. We would view any widening in securities at the top of the credit structure as a potential opportunity.**
Past performance is no guarantee of future results.
Gross Domestic Product (GDP) measures the market value of the goods and services produced by labor and property within the respective country/economic region. Bloomberg Barclays U.S. Aggregate Bond Index covers the USD-denominated, investment-grade, fixed rate, taxable bond market of SEC-registered securities. Bloomberg Barclays U.S. Mortgage-Backed Securities Index tracks agency mortgage backed pass-through securities, both fixed-rate and hybrid ARM, guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Bloomberg Barclays U.S. Corporate Investment-Grade Index covers all publicly issued U.S. corporate, non-corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements, to qualify, bonds must be SEC-registered. Bloomberg Barclays U.S. Treasury Index measures the performance of the public obligations of the U.S. Treasury with a remaining maturity of one year or more are nonconvertible and are denominated in U.S. dollars. Securities must be rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratings agencies: Moody’s, S&P, and Fitch. If only two of the three agencies rate the security, the lower rating is used to determine index eligibility. If only one of the three agencies rates a security, the rating must be investment-grade. These indexes are unmanaged and does not reflect the fees and expenses associated with a mutual fund. An investor cannot invest directly in an index.
Past performance does not guarantee future results. The performance data quoted represents past performance and current returns may be lower or higher. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. To obtain performance information current to the most recent month end, call 800-762-7085 or visit us at www.cavanalhillfunds.com.
An investor should consider a fund’s investment objectives, risk and charges and expenses carefully before investing or sending money. This and other important information about an investment company can be found in the fund’s prospectus. To obtain a Cavanal Hill Funds prospectus or summary prospectus, please call 800- 762-7085 or visit us at www.cavanalhillfunds.com. Please read it carefully before investing.
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