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Fixed income

Managers riding on crest of passive domestic growth

Josh Barrickman said creating a quality bond index fund can be a tough assignment.

Passively managed domestic fixed-income assets surged in 2016.

Pensions & Investments' annual survey of institutional money managers found U.S. institutional tax-exempt assets managed internally in indexed domestic bond strategies rose 16.8% for the year, to $639.4 billion.

A 39.8% increase to $169.3 billion in 2016 made Vanguard Group Inc. the largest passive domestic fixed-income manager in P&I's universe. Vanguard's passively managed domestic bond AUM has significantly increased in recent years, with 2016's total more than double the firm's $80.7 billion in 2012.

“In general, what you've seen over the last few years is continued adoption of passive fixed income in the space traditionally associated with equity investing,” said Josh Barrickman, Vanguard's Malvern, Pa. -based principal, senior portfolio manager and head of fixed income indexing Americas.

Investors are looking for the same quality in passive fixed income that they have come to expect from equity index strategies but constructing passive bond funds is less straightforward than tracking an equity index, Mr. Barrickman said.

“Passive investing in the bond market is different than what you see in equities. There's a lot of technique and experience that comes into play and we feel very good about our ability to deliver a quality passive bond product. (AUM growth) is a consequence of that,” he said.

BlackRock (BLK) Inc. (BLK) was the second-largest passive domestic fixed-income manager in 2016, with a 10.5% increase to $161.6 billion, followed by State Street Global Advisors' 12.1% increase to $109.9 billion in 2016.

For the 10 largest managers of passive domestic fixed income, assets rose 8.5% to $574.6 billion in 2016, from $529.6 billion one year earlier. The Bloomberg Barclays U.S. Aggregate bond index returned 2.65% for the year.

“It was a good year for fixed income, in general,” said Dan Lomelino, director and head of North American fixed-income manager research at Willis Towers Watson PLC in Chicago.

“You had the desire from corporate (defined benefit) plans to derisk, and inflows from there into the institutional fixed-income space. In (defined contribution), we can talk about interest in core, core-plus and unconstrained. And there have been asset flows into U.S. fixed income from international investors,” Mr. Lomelino said.

In terms of sector performance, he said high-yield fixed income notably outperformed during the later months of 2016 as commodities markets recovered from previous quarters of stress.

“You had a minicycle for the oil and energy names. After February, the higher-beta, more risky names performed really well,” Mr. Lomelino said.

Assets managed in high-yield securities rose 1.8% in 2016 to $173.8 billion and the Credit Suisse High Yield index returned 18.39% for the year ended Dec. 31.

Record-breaking year

Bryon Willy, the Chicago-based principal and head of North American fixed-income research at Mercer, said the investment-grade fixed-income sector also had notable developments in 2016, with another record-breaking year of corporate bond issuance.

“For now, it seems like the makeup of the investment-grade corporate bond market is a little bit different,” Mr. Willy said.

Increased corporate bond issuance was driven by many factors in addition to traditional capital-raising reasons. One such factor was the issuance of new standards from the Financial Stability Board in 2015, which changed the minimum loss-absorbing capacity for global systemically important banks and led some well-capitalized banks with that designation to issue debt. Other factors were was M&A deals in which debt was used and negative net-debt corporations that issued bonds as part of a tax-inversion strategy to repatriate assets from non-U.S. legal structures, he said.

Looking back on 2016, Mr. Willy said investment-grade corporate debt was “less tethered to the economic cycle.”

Assets managed in core fixed income rose 11.8% to $801.5 billion for the 10 largest core bond managers, and assets in core-plus strategies increased 10.9% to $288.6 billion for the 10 largest managers.

Vanguard was the largest manager of core bond strategies in P&I's universe in 2016, rising 35.1% to $194.9 billion from $144.2 billion in 2015, when it also ranked first. NISA Investment Advisors LLC rise to second-largest with a 12.5% increase to $120.6 billion, followed by SSGA's 8.6% increase to $120.4 billion.

In core-plus, a 16.6% rise to $75.2 billion made TCW Group Inc. the largest manager of that strategy in P&I's universe, followed by Pacific Investment Management Co., with $72.5 billion, down 8.8% from its 2015 total, and Loomis Sayles & Co. LP's 6% increase to $32.7 billion.

Actively managed domestic fixed-income assets stayed relatively flat in 2016, at $3.002 trillion vs. $3.004 trillion one year earlier.

PIMCO was once again the largest active domestic bond manager in P&I's universe, with $247.6 billion as of Dec. 31, down from $258 billion in 2015. Nuveen, formerly TIAA Global Asset Management, remained in second place with a 13.8% increase to $208.9 billion and Prudential Financial remained the third largest with a 4.5% increase to $191 billion.

For the 10 largest active domestic fixed-income managers, assets increased 4.2%to $1.43 trillion.

International fixed-income assets fell 1.3% to $323.5 billion in 2016. Included in that amount, passively managed international bond assets dropped 6.1% to $21 billion.

Nuveen was the largest active international fixed-income manager with $32.6 billion in 2016, up 9.8%. SSGA was the largest passive international fixed-income manager in P&I's universe, despite a 5.8% drop in those assets to $13.4 billion during the year.

The Bloomberg Barclays Global Aggregate bond ex-U.S. index returned 1.49% in 2016.

In other traditional fixed-income categories, inflation-protected securities rose 10.7% to $109.3 billion, stable value assets increased 3.8% to $478.1 billion and bank loans fell 1.8% to $38.3 billion.

This article originally appeared in the May 29, 2017 print issue as, "Managers riding on crest of passive domestic growth".