Bond Fund Commentary
Longer-duration fixed income yields drifted lower throughout the quarter, while short-duration yields moved higher as the Federal Reserve (the Fed) pulled a potential rate hike slightly forward. Lower yields were a result of not only a concerted effort by the Federal Reserve to tamp down inflation expectations, but also a market which was likely oversold at the end of the first quarter of 2021 and naturally corrected some during the second quarter. This resulted in a flatter yield curve and strong performance in the fixed income markets overall. Low quality assets once again outperformed high-quality issues, and securities with liquidity risk generally had better returns than highly liquid securities.
Positioning the Bond Fund
Portfolio composition is subject to change.
We expect yields to move higher in the second half of the year, responding to inflationary pressures and strong economic growth. While we are not calling for runaway inflation, we would not be surprised to see it a bit higher and stickier than the Fed is projecting. We have positioned the Cavanal Hill Bond Fund with a lower duration than its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, and we are alert for a spike in yields, which would cause us to add duration. We believe that overweights to both credit and liquidity risks should benefit the fund in this environment. We believe that both credit and liquidity risks should benefit in this environment.
Notable Portfolio Changes During the Quarter
Duration was relatively stable during the quarter. We added some further credit risk and liquidity risk to the portfolio during the quarter, though these additions were marginal.
Why Should Investors Consider Investing in This Fund?
Investors in this Fund should be able to reduce their exposure to rising interest rates, while retaining exposure to credit and liquidity risks. We believe credit is likely to outperform as earnings grow, corporate/municipal balance sheets are repaired, and creditworthiness improves. The yield premium for liquidity risk appears very attractive given the relatively high liquid nature of financial markets today, and this premium can be a significant boost to the yield of the portfolio, given the low level of overall rates.
Fixed income securities are subject to interest rate risks. the principal value of a bond falls when interest rates rise and rise when interest rates fall. During periods of rising interest rates, the value of a bond investment is at greater risk than during periods of stable or falling rates. Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in prices, especially for longer-term issues and in environments of changing interest rates.