Quarterly Fund Commentary
WRA Government Securities Fund
March 31, 2016
Rick Perry, CFA
Market Sector Update
- The U.S. Treasury market was fairly volatile in the quarter, after the Federal Reserve Board (Fed) raised short-term rates in December 2015. As 1Q progressed, it was somewhat clear that the Fed would use a very measured pace for future increases. Therefore, interest rates ended 1Q lower than they started. The 10-year Treasury ended the quarter at 1.77% vs. 2.27% at the start of the year, or 50 basis points, or bps (0.50 percent), lower. The yield curve shifted down and continued to flatten during 1Q. The spread between the 2-year and 10-year Treasuries tightened 19 bps (0.19 percent).
- Current market expectations are that the Fed will most likely raise short-term rates no more than two times in the remainder of 2016. The prospects for significantly higher interest rates in the first half of 2016 seem to be a fairly low probability.
- Despite significant volatility outside of the U.S. economy, the macro-economic backdrop in the U.S. continued to be reasonably supportive in 1Q, with the main exception being the energy sector. Aside from the energy sector, the slow, steady growth the U.S. economy has been experiencing is generally supportive for the fixed income market. However, there are a number of concerns internationally that could prove problematic for significantly raising rates in the near future. Other central bank policies seem to be diverging from the Fed's strategy.
- As it became clear that the Fed was on a measured pace for interest rate changes and rates outside the U.S. continued to decline, the Fund changed its duration posture from slightly short to slightly long, relative to the benchmark. The change is duration posture was beneficial to performance in 1Q. In addition, the Fund continued to position to benefit from a yield curve flattening.
- At the end of 1Q, the spread between the 2-year and 10-year Treasuries was 105 bps (1.05 percent). With expectations that the Fed will raise short term rates at a measured pace in 2016 and low domestic/global economic growth expectations, the yield curve is expected to continue to flatten further. Therefore, the Fund will likely look to extend duration on some of the Fund’s Treasury positions and sell some shorter duration Treasury positions. In addition, the Fund’s exposure to mortgage-backed securities is expected to be increased.
- The Fed is expected to employ a gradual pace when increasing short-term interest rates, stating that all decisions will be data dependent throughout 2016. The Fed’s stance will most likely result in one or two rate hikes during the year. Should the Fed execute on their stated gradual pace for rate hikes, we believe the yield curve will continue to flatten throughout the year and not be particularly disruptive. However, there is a significant risk that the Fed will act in a way inconsistent with market expectations, which would likely lead to market turbulence.
- The lack of coordinated central bank policies and uncertain economic growth has likely slowed the Fed’s plans to tighten the money supply. Predicting the near-term path of interest rates is difficult given the Fed’s desire to raise rates while also considering other central bank policies outside of the U.S., which may be inconsistent with the Fed’s announced strategy.
The opinions expressed in this commentary are those of the Fund's managers and are current through March 31, 2015. The managers' views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is not a guarantee of future results.
Risk factors. As with any fund, the value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Fund may&br;fall as interest rate rise. These and other risks are more fully described in the Fund's prospectus.
Waddell & Reed Investments refers to the investment management services offered by Waddell & Reed Investment Management Company, the investment manager of the Waddell & Reed Advisors Funds, distributed by Waddell & Reed, Inc.