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Positive Sentiment and market conditions continued positive shift
Trends that were in place in the second quarter continued into the third quarter, resulting in positive returns for the fixed-income markets. Capital market conditions continued to improve and liquidity increased for a wide range of issuers. The government’s efforts to revive various sectors of the credit market continued to take hold, and yield spreads narrowed further. Mortgage-backed (MBS), asset-backed (ABS) and commercial mortgage-backed (CMBS) securities continued to benefit from their inclusion in the Term Asset-Backed Loan Facility (TALF) program. Corporate bond valuations rebounded strongly after being punished in the last half of 2008. In September, fixed-rate supply recorded its heaviest month ever.
With economic growth outweighing inflation as a concern, monetary policy remained unchanged. The Federal Reserve Board (the Fed) kept the federal funds target rate at between zero and 0.25%, where it has been since December 2008. In this environment, the yield curve flattened about 14 basis points between the one- and five-year part of the curve. Government stimulus spending and borrowing have raised the possibility of higher inflation. However, we continue to believe 1) that the Fed is unlikely to raise short-term rates until growth picks up and 2) that monetary policy will remain accommodative for an extended period of time.
As market sentiment and technical factors continued to improve, lower-quality issues generally outperformed those of higher quality in the third quarter. The Barclays Capital Credit Index recorded its second best quarterly performance on record. The Barclays Capital 1 - 3 Year Credit Index outperformed same-duration Treasuries by 2.3 percentage points. Short-duration AAA-rated CMBS and AAA auto ABS outperformed by three and six percentage points, respectively. Overweights in these securitized sectors helped the fund outperform its benchmark, the Barclays Capital 1 - 3 Year Government/Credit Bond Index.
Overweights aided performance
All major non-Treasury sectors within the short-term bond market outperformed Treasuries during the third quarter. Overweights in the MBS, ABS and CMBS sectors, as well as an overweight in corporate securities, resulted in a return advantage for Columbia Short Term Bond Fund. Within the corporate sector, exposure to finance, insurance and REIT subsectors was positive for performance, as these subsectors were among the top performers in the corporate market. With respect to credit quality, the Baa portion of the Barclays Capital 1 - 3 Year Credit Index performed best, generating 3.65% of excess return.
In early September, we shortened duration within the fund to be slightly shorter than the duration of the benchmark. Although Treasury yields declined by a few basis points in September, two- to three-year yields actually rose a few basis points. As a result, our duration reduction had a small positive impact on performance relative to the benchmark. To take advantage of a steeper-than-normal yield curve, we also maintained a more barbelled positioning within the fund. As the curve flattened between one and five years, this positioning also aided performance.
High quality bias detracted from returns
The fund’s bias toward higher-quality securities detracted from returns in the third quarter because lower-quality securities outperformed. However, the fund’s high-quality focus served it better during the market turmoil of 2008. Approximately 8.0% to 10.0% of fund assets were invested in Treasuries during the period.
Market outlook
Looking ahead, we plan to proceed with caution as concerns about a growing supply of bonds and increased prospects for inflation in the medium to long term keep pressure on long-term rates, while continued macroeconomic weakness and accommodative Fed policy keep short-term rates low. However, we believe that the prospects for a modest economic recovery over the next few quarters could push interest rates to the higher end of their current trading range. As a result, we are targeting a portfolio duration that is slightly shorter than the fund’s benchmark, while maintaining a barbelled positioning to take advantage of the steep yield curve and better roll-down in the five-year part of the curve.
In addition, the fund remained underweight in Treasuries, which we believe can continue to aid performance in the period ahead. Because corporate debt remains inexpensive by historical standards, we remain positive in our outlook for this sector. Within the corporate market, we favor financial paper from industries such as banking and insurance and utility paper with a focus on the natural gas pipeline sector. We continue to favor mortgage securities that are agency-guaranteed. Within ABS, we continue to target well-secured, very short AAA-rated auto securities. And, we remain invested in seasoned CMBS holdings that amortize fully without the need for borrowers to refinance balloon payments.
Performance data quoted represents past performance, and current performance may be lower or higher. Past performance is no guarantee of future results.
Please read and consider the investment objectives, risks, charges and expenses for any fund carefully before investing. For a prospectus, which contains this and other important information about the fund, contact your Columbia Management representative or financial advisor or go to www.columbiamanagement.com
The Barclays Capital 1-3 Year Credit Index measures the performance of investment grade corporate debt and sovereign, supranational, local authority and non-U.S. agency bonds that are U.S. dollar denominated. The Index includes investment grade U.S. credit securities that have a remaining maturity of greater than or equal to 1 year and less than 3 year and have more than $250 million or more of outstanding face value.
The Barclays Capital MBS Conventional 15 Year Indexa subset of the Barclays Capital U.S. MBA Index which measures agency mortgage-backed passthrough secsecurities (both fixed-rate and hybrid ARM) issued by Ginnie Mae , (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).
The Barclays Capital ABS Auto AAA Indexa subset of the Barclays Capital The U.S. Fixed-Rate Asset-Backed Securities (ABS) Index, covers fixed-rate ABS with the following collateral types: credit cards, autos, home equity loans and stranded-cost utility (rate reduction bonds). To be included in the index, an issue must have a fixed-rate coupon structure, have an average life greater than or equal to one year, and be part of a public offering.
Effective November 3, 2008, the Lehman Brothers indices were renamed Barclays Capital indices.
1Determinations of contributors and detractors are based on performance relative to the fund’s benchmark.
As of 01/01/2009, Merrill Lynch & Co., Inc. is a wholly owned subsidiary of Bank of America Corporation and an affiliate of Columbia Management.
Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The views and opinions expressed are those of the portfolio managers and analysts of the affiliated advisors of Columbia Management Group, are subject to change without notice at any time, may not come to pass and may differ from views expressed by other Columbia Management associates or other divisions of Bank of America. These materials are provided for informational purposes only and should not be used or construed as a recommendation of any security or sector.
There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any securities transaction or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions made in the future will be profitable or will equal the investment performance of the securities discussed herein.
Columbia Management Group, LLC (“Columbia Management”) is the investment management division of Bank of America Corporation. Columbia Management entities furnish investment management services and products for institutional and individual investors. Columbia Funds are distributed by Columbia Management Distributors, Inc., member FINRA and SIPC. Columbia Management Distributors, Inc. is part of Columbia Management and an affiliate of Bank of America Corporation. |