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Strategic Global Income Fund, Inc. (the "Fund") (NYSE: SGL) is a non-diversified, closed-end management investment company seeking a high level of current income as a primary objective and capital appreciation as a secondary objective through investments in US and foreign debt securities.
Fund Commentary for the first quarter of 2013 from UBS Global Asset Management (Americas) Inc. (“UBS Global AM”), the Fund’s investment advisor
The markets were volatile at times during the first quarter given uncertainties surrounding US fiscal and monetary policy, geopolitical concerns, inconclusive elections in Italy and a banking crisis in Cyprus. Despite speculation that the US Federal Reserve Board (the “Fed”) may moderate quantitative easing sooner than expected, Fed Chairman Ben Bernanke reiterated his commitment to policy accommodation.
The US spread sectors (i.e., non-US Treasury fixed income securities) largely treaded water during the first quarter and generally performed in line with equal duration Treasuries. The US yield curve steepened during the quarter as short-term yields were relatively flat, whereas longer-term yields moved higher given expectations of future inflation. All told, the overall US bond market, as measured by the Barclays US Aggregate Index, declined 0.12% during the first three months of the year.
While most spread sectors were generally flat during the quarter, there were two notable exceptions: high yield corporate bonds and emerging market debt. High yield corporate bonds generated solid absolute and relative returns given overall robust demand from investors seeking to generate incremental yield. All told, the Bank of America Merrill Lynch US Cash Pay High Yield Constrained Index returned 2.87% during the quarter. The high yield market was supported by overall strong demand, positive corporate fundamentals and continued low defaults. From a ratings perspective, better-quality rating categories broadly underperformed lower-quality bonds, with the BB- and B-rated segments lagging the CCC and below-rated segment.
The overall emerging markets debt asset class performed poorly during the quarter, due to moderating global growth, falling commodity prices, fears of contagion from Europe and rising Treasury yields. Within the emerging markets asset class, US dollar-denominated emerging markets debt, as measured by the JP Morgan Emerging Markets Bond Index Global (EMBI Global), posted a -2.30% return over the reporting period, while local currency emerging markets debt, as measured by the JP Morgan Government Bond Index-Emerging Markets Global Diversified (GBI-EM Global Diversified), posted a -0.13% return during the same time period.
During the first quarter of 2013, the Fund posted a net asset value total return of -1.27% and a market price total return of 0.20%. On a net asset value basis, the Fund outperformed its benchmark, the Strategic Global Benchmark (the “Index”)1, which declined 2.62% for the quarter.
The Fund's spread sector exposures drove its outperformance during the first quarter.2 In particular, overweights and security selection of high yield corporate bonds and commercial mortgage-backed securities (CMBS) were beneficial for performance. An overweight to investment grade corporate financials and an out-of-benchmark allocation to agency mortgage-backed securities (MBS) were also positive for relative performance. Elsewhere, an underweight to emerging markets debt was beneficial for relative results, as the asset class generated weak results during the quarter.
Overall, duration and yield curve positioning detracted from results, largely due to non-US dollar rate positioning. In terms of the Fund's high yield exposure, allocations to energy, services and gaming added the most value. Our exposures to cable television, telecommunications and insurance were also beneficial, albeit to lesser extents. Security selection within those sectors was also positive for performance. However, our allocations to the steel and food/drug retail sectors, along with security selection in the bank sector, were modest drags on results.
With respect to the Fund's emerging markets debt exposure, overweight positions to a number of countries detracted from performance during the quarter. For example, our overweight to Argentina was detrimental for results. During the fourth quarter of 2012, a US court ruled that Argentina could not discriminate between its creditors, in connection with a longstanding dispute between holdouts from Argentina’s 2001 sovereign default. Against this backdrop, Standard & Poor's cut the country’s credit rating to B-, from B; Moody’s lowered the country’s rating to B3 from B2; and Fitch placed the country’s B rating on Rating Watch Negative. Investor sentiment for Argentina's debt remained weak as appeals in the court case have yet to be resolved. After a long period of outperformance, local Brazilian debt generated poor results, and our overweight position was detrimental for returns. This turnaround was driven by inflationary pressures and expectations for the beginning of a rate hike cycle by its central bank. Elsewhere, selection of local currencies was a negative for performance. In particular, our overweight to the Korean won was not rewarded, as it weakened given increased political risk and the weakening Japanese yen.
Overall, we have a positive outlook for the US economy. While the expansion will likely be far from robust, we believe that growth is sustainable, in part due to the rebound in the housing market. This, in turn, should be supportive of consumer spending. Our view for growth outside the US is less encouraging, as Europe's economy remains in a recession, and the recent banking crisis in Cyprus illustrates that the region's sovereign debt crisis is far from resolved. Elsewhere, the Bank of Japan has taken aggressive actions to support its economy and end deflation; however, it remains uncertain whether these initiatives will be successful.
We remain positive for the US corporate bond market. Corporate fundamentals are solid overall, with balance sheets that are oftentimes flush with cash. Many US companies have also taken advantage of historically low interest rates to refinance their debt and extend maturities. Against this backdrop, we expect default rates to remain below their historical average. Finally, given continued Fed policy accommodation, we believe that investor demand will be strong overall. That said, we do not expect to see corporate bond returns to be as robust as they were in 2012. In addition, we are keeping a close eye on the potential for investors to rotate a portion of their assets from bonds to stocks, in search of higher returns.
Overall, we have a positive outlook for emerging markets debt. Within the asset class, we believe that local currencies are likely to continue to outperform US dollar-denominated emerging markets debt in 2013. We expect to see emerging market growth rates remain stronger than for developed market countries. In addition, we believe that the Federal Reserve Board, the Bank of Japan and the European Central Bank will continue pursuing their accommodative monetary policies. Conversely, many emerging market central banks appear closer to ending their easing cycles. In such an environment, the yields difference between local emerging and developed country bonds should remain stable or increase, which should be beneficial for local currencies. Lastly, we maintain a neutral outlook for local bonds.
Disclaimers Regarding Fund Commentary - The Fund Commentary is intended to assist shareholders in understanding how the Fund performed during the period noted. Views and opinions were current as of the date of this press release. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the Fund and UBS Global AM reserve the right to change views about individual securities, sectors and markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Fund’s future investment intent.
Past performance does not predict future performance. The return and value of an investment will fluctuate so that an investor's shares, when sold, may be worth more or less than their original cost. Any Fund net asset value ("NAV") returns cited in a Fund Commentary assume, for illustration only, that dividends and other distributions, if any, were reinvested at the NAV on the payable dates. Any Fund market price returns cited in a Fund Commentary assume that all dividends and other distributions, if any, were reinvested at prices obtained under the Fund's Dividend Reinvestment Plan. Returns for periods of less than one year have not been annualized. Returns do not reflect the deduction of taxes that a shareholder would pay on Fund dividends and other distributions, if any, or on the sale of Fund shares.
1 The Strategic Global Benchmark is an unmanaged index compiled by the advisor, constructed as follows: 67% Citigroup World Government Bond Index (WGBI) and 33% JPMorgan Emerging Markets Bond Index Global (EMBI Global). Investors should note that indices do not reflect the deduction of fees or expenses.
2 “Spreads” refers to differences between the yields paid on US Treasury bonds and other types of debt, such as emerging market bonds.