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Special Report: Top-Performing Managers

High-yield fixed income continues its winning ways

Morningstar's Emory Zink
Morningstar’s Emory Zink

High-yield bond strategies led the list of top fixed-income performers for the second consecutive quarter, taking seven of the top 10 spots for the year ended June 30, according to Morningstar Inc.'s separate account/collective investment trust database.

Emory Zink, fund analyst, fixed-income strategies at Morningstar in Chicago, said strong relative returns for high yield, which outperformed investment-grade corporates by roughly 2 percentage points, were only part of a very busy second-quarter fixed-income story.

In addition to the outperformance of lower-tiered corporate credit segments, the environment also favored managers of core-plus strategies that had exposure to asset-backed securities, with auto loans and other consumer debt continuing to produce compelling returns during the second quarter, she said.

While the Treasury yield curve flattened further, Ms. Zink said "the longest end slightly dipped, generating a 0.31% return that outpaced the more modest 0.1% of the broader U.S. Treasury index over the quarter."

Outside of the U.S. fixed-income markets, she said, "a strengthening dollar put pressure on non-U.S. dollar denominated holdings, resulting in challenges for foreign-currency denominated bonds. The unhedged (Bloomberg Barclays') Global Aggregate Bond index lost 2.78% for the quarter, while the (JP Morgan) Emerging Markets Local-currency index plummeted 10.42%."

Central bank watchers saw Chairman Jerome H. Powell continue as a steady hand at the Federal Reserve during the quarter, raising rates a quarter-point in June, while the European Central Bank discussed slowing its quantitative easing program. Global events such as U.S. sanctions on Russia and President Donald Trump's decision to impose tariffs on U.S. imports of steel and aluminum contributed to uncertainty around the future economic outlook for domestic fixed income, Ms. Zink said.

"All of this happened during the second quarter," she said.

The median return for domestic high-yield strategies in Morningstar's universe was 2.64% for the one-year period, while the median return for Morningstar's entire domestic fixed-income universe was 0.37%.

The Bloomberg Barclays U.S. Corporate High-Yield index returned 2.62% for the year ended June 30 and the Bloomberg Barclays U.S. Aggregate Bond index returned -0.4%.

Top-performing managers: Overall U.S. bonds
One-year returnCategoryGross returnNet return
Herzfeld Fixed Income CompositeU.S. SA high-yield bond10.45%9.65%
DDJ bank loan StrategyU.S. SA bank loan8.44%7.86%
MacKay Select High Yield CompositeU.S. SA high-yield bond7.36%6.67%
Octagon Senior Secured CreditU.S. SA bank loan7.11%6.42%
TCW Opportunistic MBSU.S. SA high-yield bond6.99%6.25%
DDJ Total Return Credit II CompositeU.S. SA high-yield bond6.69%5.55%
Potomac Muni PlusU.S. SA muni national long6.56%3.92%
Shenkman Capital Multi-Strategy CompU.S. SA high-yield bond6.39%5.62%
DDJ U.S. Opportunistic High Yield CompU.S. SA high-yield bond6.34%5.85%
Diamond Hill High YieldU.S. SA high-yield bond6.06%5.54%
 
Five-year returnCategoryGross returnNet return
Herzfeld Fixed Income CompositeU.S. SA high-yield bond8.83%7.98%
MacKay Select High Yield CompositeU.S. SA high-yield bond7.78%7.21%
DDJ U.S. Opportunistic High Yield CompU.S. SA high-yield bond7.26%6.73%
Shenkman Capital Multi-Strategy CompU.S. SA high-yield bond7.22%6.39%
Nomura NCRAM HY Total Return InstU.S. SA high-yield bond7.19%6.66%
TCW Opportunistic MBSU.S. SA high-yield bond7.11%6.36%
Logan Circle Long CreditU.S. SA corporate bond7.02%6.63%
Lord Abbett High Yield OpportunisticU.S. SA high-yield bond7.01%6.46%
Strategic Income Mmgt SiM High Yld InstlU.S. SA high-yield bond7.00%6.58%
Morgan Stanley (MS) U.S. High YieldU.S. SA high-yield bond6.92%6.02%

'Dig in ... get specific'

Miami Beach, Fla.-based Thomas J. Herzfeld Advisors Inc.'s fixed-income composite rose to the top of Morningstar's one- and five-year lists, with a gross return of 10.45% for the year and an annualized 8.83% for the five years ended June 30. All multiyear returns are annualized.

This strategy, previously known as Herzfeld's Taxable Closed-End Bond strategy, was in fourth place on each list for the periods ended March 31.

Erik Herzfeld, president and portfolio manager, said the firm's research process found continued value in high yield and senior loans as default rates have remained low and fixed-income spreads have narrowed.

"It's very important that investors don't look just at general levels of spreads. There's a lot of overvalued high-yield securities and a lot of undervalued high-yield securities, and active management can provide a lot of value in an environment like this where the (Federal Reserve) is continuing on a hiking path. Our approach is to dig in a bit more and get specific," Mr. Herzfeld said.

DDJ Capital Management LLC's bank loan strategy rose to second place on Morningstar's overall list from sixth for the 12 months ended March 31, returning a gross 8.44% for the year ended June 30.

Focus on smaller issuers

"Our bank loan strategy is DDJ's offering in the traditional bank loan space, with the majority of the securities in first-lien syndicated term loans, as well as an opportunistic allocation to second-lien term loans and short-dated secured bonds," said John Sherman, the Waltham, Mass.-based portfolio manager of DDJ's bank loan strategy, co-portfolio manager of the firm's U.S. opportunistic high-yield strategy and assistant portfolio manager of its total return credit strategy.

Mr. Sherman said the strategy's investment in smaller issuers positioned it to take advantage of higher yield opportunities in the middle market and lower-tier segments of the first-lien leveraged loan market because ratings restrictions prevent many firms from investing in the lower tier, where DDJ's selection process has identified smaller issuers that ratings agencies have underrated based on size.

"Single B and triple C loans performed particularly well over this period of time, and there's a smaller group of people looking at that part of this space," he said.

DDJ's Total Return Credit II composite was in sixth place for the year, with a gross return of 6.69%. The strategy was in third place for the year ended March 31.

"(Total Return Credit II) is our 'best ideas' strategy with the largest weightings in our highest conviction ideas. We invest up and down the capital structure, in both loans and bonds. The strategy continues to take advantage of dislocations in the lower-middle-market space, providing a solid risk-adjusted return," Mr. Sherman said.

DDJ had one more strategy in the top 10 for both the 12-month and five-year periods. Its U.S. Opportunistic High Yield composite returned a gross 6.34% for the year, ranking ninth, and a gross annualized 7.26%, putting it in third place on Morningstar's five-year list for the second consecutive quarter.

"Our high yield is a little bit different than our peers," DDJ's Mr. Sherman said. "We have the flexibility to invest in both bank loans and bonds, which doubles the universe of ideas to invest in, and we can pick the best without restrictions against what ratings we invest in."

More specialized

The Select High Yield Composite from MacKay Shields LLC, New York, was in third place on the one-year list, with a 7.36% gross return, and in second place on the five-year list with a gross annualized 7.78% for the period.

"This is a more specialized fund," said Eric Gold, portfolio manager on the high-yield team at MacKay Shields. "We take a subsection of the overall portfolio, and we are willing to accept a higher volatility and greater risk in the realization of higher returns. It is the same exact process that we use in all of our portfolios, but with a lot more concentration," he said.

Mr. Gold said a consistent management process across portfolios means the select strategy takes a long-term view of the high-yield market.

"It's not a large asset class and it's very much a flow asset class, and we avoid the 'hot deal' when there's an asymmetry of risk/return because that's a short-term focus. Every bond we own, we think about it as a lender, as if we had to own that bond to maturity. Fundamentally, from the bottom up, we pay a lot less attention to short-term noise, and that's really how we differentiate ourself," Mr. Gold said.

Rounding out the top five on the one-year list, Octagon Credit Investors LLC's Senior Secured Credit strategy was in fourth place with a one-year gross return of 7.11% and TCW Group Inc.'s Opportunistic Mortgage-Backed Securities strategy was in fifth place with a 6.99% return for the year.

In the five-year ranking, Shenkman Capital Management Inc.'s Multi-Strategy composite ranked fourth, with a gross annualized 7.22%, followed closely by Nomura Corporate Research and Asset Management Inc.'s High Yield Total Return Institutional strategy, which was in fifth place with 7.19%.

The annualized return for Bloomberg Barclays' U.S. Corporate High-Yield index was 5.51% for the five-year period, the median return for high-yield strategies was 5.26%, and the entire Morningstar domestic fixed-income universe returned a median 2.77%.

Commingled universe

DDJ's Total Return Credit I composite topped the one- and five-year lists in Morningstar's collective investment trust universe, with a net return of 8.34% for the year and a net annualized 7.63% for the five-year period ended June 30.

DDJ's Mr. Sherman said the commingled fund follows the same strategy as the separate accounts, taking advantage of inefficiencies in the middle market and lower-tier segments of the high-yield market.

T. Rowe Price Group Inc.'s International Bond fund was in second place for the year with a net return of 6.2%, Shenkman Capital's Four Points Multi-Strategy was third with 5.56%, followed by American Century Investments' U.S. High Yield Corporate Bond fund and Fidelity Institutional Asset Management's Leveraged Loan Pool, which each returned a net 4.12% for the one-year period.

Completing the top five CITs for the five years ended June 30 were Eaton Vance (EV) Corp.'s EB High Yield Fund, with a net annualized return of 5.64%, followed by State Street Global Advisors' U.S. Long Credit Bond Index fund, returning 5.6%, FIAM's Long Corporate Pool was in fourth place, with 5.53%, and BNY Mellon Investment Management's EB DV High Yield Beta fund with a net 5.51% annualized return.

The median return for fixed-income CITs in Morningstar's universe was -0.12% for the year and 2.5% for the five years ended June 30.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Aug. 2.