Legg Mason Western Asset Macro Opps Bd A (SSB0070AU) Report & Performance

The Fund was down 3.16% in June and down 6.48% during the June quarter. The Fund’s duration and yield-curve positioning was the most significant detractor on a net basis mainly as a result of overall long U.S. duration exposure. Exposure to investment-grade and high yield credit was also a negative contributor to performance, mainly due to energy and financials. Overall foreign exchange positioning detracted on a net basis while, developed markets foreign exchange was negative for returns, with long Australian dollar and Japanese yen exposures detracting the most. Emerging markets foreign exchange added to performance as the positive effect of long Russian ruble and short Chinese offshore yuan exposures offset the negative impact of long Brazilian real, Polish zloty and Indian rupee exposures. Mortgage and asset-backed securities were negative for returns, with collateralized loan obligations detracting the most. Emerging market debt was a net detractor mainly as result of Israeli and Brazilian debt exposures; exposure to Russia partially offset the negative impact.

Positioning over the quarter reflected the main theme that inflation and growth would moderate into year end and that the U.S. economy would avoid a recession. The Fund’s duration was positioned as a butterfly along the curve, being long in both front- and long-end rates, while short in medium-term maturities. With growth and inflation expectations both moderating late in the quarter, we were positioned for a flatter curve belly to bonds. Risk asset exposure in investment-grade and high-yield credit generally increased as spread widening reflected generous implied default rates vs. our growth outlook. A small amount of emerging market exposure was added by receiving in mid-maturity Mexican swaps and a small long position in Poland. Russian swaps were further reduced, some at levels better than the initiation price, and Russian sovereign exposure passively increased as bond pricing increased over the quarter.

The Fund was down 10.38% in March and down 18.80% for the March quarter. Within the Fund duration and yield-curve positioning was the most signifi-cant detractor on a net basis mainly due to long US duration exposure. Emerging markets (EM) debt was also a significant detractor mainly as a result of exposure to Russian rates. Overall foreign exchange (FX) positioning was a positive contributor to returns. Within EM FX, Russian ruble and Brazilian real exposures contributed the most. Within developed market (DM) FX, the Japanese yen detracted the most but its negative effect was partially offset by long Australian dollar exposure. High yield exposures, mainly energy, contributed positively to performance. Investment-grade credit, mainly CDX, energy and financial exposures, also added modestly to returns.

From a Fund positioning perspective headline duration increased by a little more than three years in March with the increase split between the 2-year key rate duration (KRD), after the mid-month repricing toward a more aggressive Fed hiking cycle, and at the long end in the 10- to 30-year KRDs to provide ballast as the war in Europe continues. Additionally, the paying on swaps position was decreased by approximately 1.5 years as 10- and 30-year invoice spreads widened mid-month. There was no change to inflation trades. We trimmed the German-US short from -4.25 years at the end of February to almost flat by monthend as 10-year rates rose significantly in Europe. In FX, the long Mexican peso and Brazilian real positions were materially reduced. In East Asian currencies, long positions in the Korean won and Malaysian ringgit were reduced, as was a short Chinese yuan position.

The Fund was up 2.08% in December and flat for the December quarter. Within the Fund duration and yield-curve positioning was the most significant contributor on a net basis mainly due to short German duration exposure. Emerging market (EM) debt was a positive contributor mainly as a result of exposure to Brazilian rates. High-yield, mainly energy exposures, and investment grade credit, mainly financial and energy exposures, also contributed significantly to performance. Within EM FX, long Mexican peso and Brazilian real exposures helped performance the most, and offset the negative effect of Russian ruble exposure. Within developed market (DM) FX, long Australian and Canadian dollar exposures helped the most and offset the negative effect of Japanese yen exposure. Within the Fund headline duration increased by almost 5.5 years taking the portfolio’s effective duration close to seven years by month-end. Although duration was added across the curve, the majority of it was added in the three- to five-year area. The swap spread position (payer) was reduced as swap spreads tightened early in the month. The US-German 10-year position was reduced by 1.6 years and the Italian-German 10-year position was reduced by 0.25 year. Positions in credit and EM debt were held constant. In EM currencies the long Indian rupee position increased by 1.2% as inflation continued to be benign (1.9%), while the currency offers high carry (6.0%) and relatively low volatility (5.1%). Additionally, Mexican peso exposures increased by 1.5% as the currency rallied through the month.

The Fund was up 2.94% in June. Duration and yield-curve positioning was the most significant contributor on a net basis, mainly as a result of overall long U.S. duration. Emerging market (EM) FX was an overall positive contributor, mainly due to long Brazilian real, Russian ruble and Mexican peso exposures. EM rates also contributed to performance, helped mostly by exposures to Mexico, Indonesia and Russia. Investment-grade credit, mainly financial and energy exposures, was positive for returns. High-yield allocations, mainly to energy names, also added modestly over the quarter.

While duration was actively managed over the quarter, there were no major changes in the recovery theme or positioning. The effective duration averaged approximately six years with a flattening bias, reflecting the view that rates were too optimistically priced relative to the pace of the recovery and that current price inflation would prove transitory. Going forward, the expectation is that as the economy recovers slowly and the Fed begins tapering and ultimately raising rates, the yield curve will flatten. Additionally, the flattening exposure adds a defensive element to the portfolio in the event unforeseen problems arise, especially those unrelated to the pandemic. With respect to risk assets, the main themes remain in investment-grade credit and EM. Over the quarter, there was some rotation out of investment-grade into high-yield energy and industrial exposures in the spirit of reopening trades. EM also remains a critical theme as Western Asset believes it represents the highest beta trade to a meaningful global economic recovery. Relative to global equities and credit, prices in the EM complex have not recovered to pre-pandemic levels and represent a tremendous value opportunity.

The Fund was up 3.87% in April. Duration and yield-curve positioning was the most significant contributor, mainly as a result of overall long U.S. and short German duration exposures. FX positioning was an overall contributor, mainly due to long Brazilian real as well as Canadian dollar and Chinese yuan exposures. Emerging market (EM) debt also contributed to performance, mainly as a result of long rate exposures in Indonesia and Brazil. High-yield and investment-grade credit exposures, mainly energy and financials, were positive for returns. Peripheral Europe was a slight contributor mainly as a result of short 10- year Italian Treasury exposures.

In terms of positioning, headline duration decreased by almost two years as yields rallied and as we continued to readjust longer duration to shorter-dated key rates. Both high-yield and investment-grade positions were slightly reduced as spreads tightened. In high-yield, about a half percent of energy was added while reducing subordinated financials and industrials for an overall net reduction. In investment-grade, mainly financials and industrials were cut as spreads tightened over the month. In EM, the local Indian rupee rates position was reduced on the back of a worsening pandemic in the subcontinent. In developed market currencies, the short euro position became flat through long calls going in-the-money.

The Fund was up 1.50% in December and the Fund rose 6.14% for December quarter. Emerging markets (EM) debt was the most significant contributor, mainly as a result of long rate exposures in Mexico, Indonesia, Russia and Brazil. Investment-grade credit was a significant contributor mainly as a result of financial and energy holdings as those spreads tightened. EM currency exposures were positive as the Russian ruble, Mexican peso and Brazilian real all strengthened versus the US dollar. High-yield was a modest contributor as a result of energy positions. Overall duration positioning detracted from perfor-mance mainly due to long US duration exposure. No major theme or position changes took place during the fourth quarter. As it has been since early 2Q20, the portfolio was positioned risk-on, to take advantage of progress toward economic normalization underpinned by extraordinary monetary and fiscal policy. Investment-grade credit, being directly supported by the Federal Reserve (Fed), was one major theme; EM countries with positive real yields was another major theme in the portfolio. With Fed Chair Jerome Powell’s commitment to keep rates near zero for the foreseeable future, and with meaningful progress toward global vaccinations, we believe EM real yields will become increasingly attractive. Toward the end of the quarter, headline duration increased by a little more than a year, with the increase concentrated in the 10- and 20-year part of the curve. A 30-year breakeven trade was closed given the more con-servative outlook for inflation, and the swap spread widener was decreased as 10-year swaps widened into positive territory. The US-German short was increased by about a quarter of a year as the spread between US and German 10-year bonds continue to widen.

What is the outlook?
The combination of the global vaccination process beginning and reasonable economic momentum aided by fiscal help should support fixed-income and risk markets. However, challenges remain with record global infection rates as well as in vaccine production, acceptance and distribution; as a result, we main-tain our base case outlook for a longer, U-shaped economic recovery. Central bank purchases will likely support continued spread compression and the liquidity of investment grade markets moving forward. Credit fundamentals remain challenged, but we expect a number of sectors to demonstrate resilience, including banking, while others continue to face downgrade pressure. We acknowledge markets remain most sensitive to statistics around COVID-19. Once we begin to see declines in the viral spread, we believe that ultimately the power of the very accommodative policies will combine with an eventual recovery in demand to propel the global economy back toward trend-line growth.
Past performance is not a reliable indicator of future performance.