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Navigating Volatility in Fixed Income Markets

Douglas Gimple

Fixed income markets have been a challenge for investors this year. Hear from senior portfolio specialist Douglas Gimple on how Diamond Hill’s fixed income team has navigated the market dynamics.

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The following text is an excerpt of the speakers’ podcast originally recorded in November 2022. This transcript solely represents the views of the individuals who spoke, which are subject to change.

Navigating Volatility in Fixed Income Markets

Jessica Schmitt, Director — Investment Communications

Doug, you're part of the Fixed Income Team here at Diamond Hill, and the team manages a Core Bond strategy and a Short Duration Securitized Bond strategy. How have they managed in this challenging environment?

Douglas Gimple, Senior Portfolio Specialist

Yeah, challenging environment without a doubt. When the Index is down double digits, the worst performance that we've ever seen for a calendar year, for a rolling 10-month timeframe — however you want to look at it. Our job, as we have always viewed it, is to mitigate that damage. We want to hold up better in down markets and capture as much of our fair share in rising markets, in well-performing markets. And so, we've been able to do that. We've mitigated some of that damage, and I know we're ahead of the benchmark. I don't have the exact number, but I'm sure we can provide that. But it's being able to limit that through a variety of different things. One, duration management: we've been about 90% of the benchmark's duration, though we're starting to get a little bit tighter to maybe the 91%, 92% in our Core Strategy.

The main reason: we don't want our thoughts on rates and where we think rates may be going to dictate all of our performance. But at the same time, if at the beginning of 2022 and actually earlier than that, we felt that rates were going to go higher and we were a little bit shorter duration, we're fine with that positioning even if it cost us a little bit around that time, knowing that the path for rates going forward was higher, not knowing exactly how fast. That's definitely helped out.

But the security selection, looking at the underlying mortgages within our portfolio, looking at collateralized mortgage obligations instead of straight pass-throughs or TBAs — a way to mitigate that duration extension that we see in mortgages. Owning more on the shorter end and shorter ABS, and that goes directly to our Short Duration strategy — focused in securitized, heavily weighted in ABS, in what we were just talking about earlier, non-agency commercial mortgages, that again, are giving us some pretty attractive yield without delving too deep into credit. Staying a little higher credit, definitely for our Core. Our Core, we're all investment grade, so it's adding value at the security level. And not wanting to be rock stars in all environments — recognizing that in 2019 when the market was running red hot fueled by strong corporate performance, we did pretty well, but we didn't keep up with the benchmark.

But we're okay with that because when you look at it over the longer term, which is what we focus on, we're able to deliver in a variety of different environments and that includes what we've seen this year. So, I think being a little bit more conservative has definitely worked well for us this year.

But I would also argue that we're very well positioned going into whatever next environment we may be in, because we've got some pretty attractive yield, especially relative to the indices, relative to competitors, without delving into below investment grade with regards to Core. And with Short, it's differentiating with the focus and securitized, and being able to deliver a very attractive yield that we felt some pain this year, even in a Short Duration strategy, but again, positioned for future performance with some very attractive yield with very low duration, and pretty attractive credit quality at anywhere from BBB+ to A- is where we'll kind of move between.

But without a doubt, it's challenging. But to be able to go to clients and say, "Hey, this fixed income market is unprecedented. The performance has been incredibly challenging. But we've protected, and we've protected as much as we can on the downside." And clients appreciate that, because again, that's what they hired us for. We're not going to hopefully surprise them in any way. We think about it more as, "This is your core, and it is meant to be the stabilizer in your portfolio. And maybe not this year, at least total return wise, but from a relative standpoint." And then, with Short, it's delivering a differentiated product that, again, this year, performance isn't great — relative, it is — and again, it's positioned for, we think, some pretty strong performance going forward.

Jessica Schmitt, Director — Investment Communications

Well, great, Doug. Thank you. It's a pleasure having you on as always.

Bloomberg US Aggregate Bond Index measures the performance of investment grade, fixed-rate taxable bond market and includes government and corporate bonds, agency mortgage-backed, asset-backed and commercial mortgage-backed securities (agency and non-agency). Bloomberg US 1-3 Year Government/Credit Index measures the performance of investment grade government and corporate bonds with maturities of one to three years. The indexes are unmanaged, include net reinvested dividends, do not reflect fees or expenses (which would lower the return) and are not available for direct investment. Index data source: Bloomberg Index Services Limited. See for a full copy of the disclaimer.

Risk disclosure: In general, when interest rates rise, fixed income values fall. Mortgage- and asset-backed securities are influenced by factors affecting the housing market and the assets underlying such securities. The securities may decline in value, face valuation difficulties and become more volatile and/or illiquid. They are also subject to prepayment risk, which occurs when mortgage holders refinance or repay loans sooner than expected, creating an early return of principal to loan holders.

TBA, or to-be-announced, is a term that describes forward-settling of mortgage-backed securities where certain details may not be known until later. ABS, or asset-backed securities, are financial securities backed by income-generating assets such as credit card receivables, home equity loans, student loans or auto loans. Credit Quality: Security quality ratings are derived from underlying portfolio securities by using the middle rating of Standard & Poor’s, Moody’s and Fitch. If only two of Standard & Poor’s, Moody’s and Fitch rates a security the higher of the two is selected. If only one of Standard & Poor’s, Moody’s and Fitch rates a security the available rating is used. For securities that are not rated by Standard & Poor’s, Moody’s or Fitch a rating from a secondary Nationally Recognized Statistical Rating Organization (“NRSRO”) may be used. Ratings by any agency represent an opinion only, not a recommendation to buy or sell. Securities that are not rated by any agencies are reflected as Not Rated “NR.”

The views expressed are those of the speakers as of November 2022 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results.

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