December 2020

The Halyard Asset Management Reserve Cash Management (RCM) strategy generated 1.23% after fees and expenses for the year.  That compares favorably to the 0.32% total return of the iMoneyNet Money Fund average.  As of January 1, 2021, the RCM strategy has a duration of less than 5 months and a weighted average yield to maturity of approximately 0.37%.  In comparison, the benchmark has a yield-to-maturity of 0.00% due to the high management fees associated with those funds and the current low interest rate environment.  Aside from Treasury Bills, the top 5 RCM holdings are Toyota Motor Credit, Allstate Corporation, Lowe’s, Ralph Lauren, and Oracle.  The composite is overweight floating-rate notes, a structure that typically performs well when interest rates rise.  While we don’t anticipate an interest rate hike anytime soon, floaters are attractive relative to fixed rate paper.

Last year was a fabulous period for holders of risky assets.  The total return including dividends for the S&P 500 was 16.26%, the yield-to-maturity of the 10-year Treasury note fell more than 100 basis points and Comex Gold rallied more than 25%.  Similarly, the Pound Sterling appreciated 3.05%, the Japanese Yen by 5.16%, while the Euro rose 8.93%, all three versus the U.S. Dollar. 

That risky assets could rise in tandem despite an absolutely awful operating environment is entirely attributable to Federal Reserve and their easy money policies.  Given the above mentioned performance we ask the question how much did it cost to generate?  To approximate that number, we look to the Federal Reserve System’s Open Market Account (SOMA), which is published biweekly on the Central Bank’s website.  As of December 30th 2020, the Fed held $6.687 trillion in Treasury notes, bonds, Agency securities, and Agency Mortgage Backed bonds.  That is $2.97 trillion more than they held at the end of 2019, an eye-popping 80% increase in holdings.  The Fed’s job has historically been to act as an “invisible hand” when intervening in the financial system.  In that, the Fed should not destabilize or distort valuation as they endeavor to keep the system operating smoothly.  In buying nearly $3 trillion of notes and bonds in the secondary market, their operation is more like a punch in the face than an invisible hand. 

Of course, last year there were special circumstances, and they needed to act deliberately to ensure the entire system didn’t collapse, and are unlikely to repeat that this year, right?  Partly yes and partly no.  They are unlikely to increase their holdings by 80% year-on-year, but at their current pace of buying, which they have explicitly told us they would continue for the foreseeable future, they are on pace to add another $1.44 trillion to their holdings in 2021. 

The logical question is that if they are going to only do about half of what they did in 2020 can we expect similar capital market performance in 2021?  In bonds, probably not.  We sensed some real selling pressure at the end of last year, with the Japanese and Chinese both reducing their holdings of Treasuries.  Should the health authorities contain the coronavirus and economic activity bounce back we wouldn’t be surprised to see the yield-to-maturity of the 10-year note rise to 1.50%.  However, we do not think the Fed would be happy with such a move and could envision the Central Bank skewing their secondary market buying to longer maturities.  In this environment, where we see the potential for negative total return longer maturity fixed income, we believe that the RCM is an attractive alternative to cash, money market funds and longer term fixed income holdings.

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