Long duration fixed-income managers are looking ahead to a better 1995 after getting killed in 1994 by rising interest rates.
The Pensions & Investments Performance Evaluation Report for managed accounts shows the median long duration manager to be the worst performing class of fixed-income manager in 1994, posting a return of -6.7%. That return came despite a relatively strong showing in the final quarter, when the median long duration PIPER manager returned 1%, ahead of all other classes.
At the same time, the median manager in the Broad Market Fixed Income PIPER account returned -2.9% in 1994. The Lehman Brothers Government/Corporate Long Term index returned -7.1%, and the Salomon Brothers Broad Bond index returned -2.85%.
"Nowhere to hide" was a popular way to describe the fixed-income investment climate in 1994, said Mark Anderson, vice president for Renaissance Investment Management, Cincinnati. For example, 1994 was the worst year ever for the five-year Treasury note market, he said.
Kenneth Thomae, vice president and portfolio manager for Fleet Investment Advisors, Providence, R.I., said even during the inflation-shocked 1970s there wasn't a calendar year with returns as bad as 1994's.
Fixed-income prices fell last year as the Federal Reserve raised interest rates six times. More hikes could come this year, although some believe the Fed is about finished trying to slow the economy with higher rates.
Renaissance had the highest ranked long duration separate account for 1994, returning -2.3%. Mr. Anderson said Renaissance shortened its duration pretty early in 1994, boosting its return over the course of the year. (Duration is a measure of fixed income security cash flows over time).
Shorter term managers in general outperformed other styles in 1994, with the median limited duration manager of managed accounts posting a return of 1.2%, and the median intermediate manager posting a return of -1.6%, according to PIPER. In addition, cash and intermediate term managers dominated the top listing of all fixed-income managers in the PIPER database, taking eight of 10 slots for the year.
The Lehman Government/Corporate Intermediate Index returned -1.9%, the Merrill Lynch 1-3 Year Treasury Index returned 0.6%, while 90-day T-bills returned 3.9%.
Other relatively strong performing fixed-income sectors in 1994 were international fixed-income accounts and high yield accounts, which posted median returns of 0.6% and -1.4% respectively. The J.P. Morgan Non-U.S. Government Bond Index returned 4.9%. The Salomon High Yield index returned -1.3%.
Fixed-income managers at Miller Anderson & Sherrerd, West Conshohocken, Pa., used a barbell strategy in 1994, which helped returns at a time when the yield curve is flattening, said Thomas Bennett, partner and member of the fixed-income team. A barbell strategy involves emphasizing securities with both shorter and longer durations, but avoiding intermediate durations.
The firm had the fourth highest ranked long duration separate account in 1994, posting a return of -3.8%.
Likewise, shortening duration was one of the ways managers at Executive Investment Advisors Inc., Fort Washington, Pa., tried to outperform the market in 1994, said Tarey Gabriele, senior partner. Executive Investment turned defensive on the market in July or August of 1993, he said.
"Our primary concern was that (Fed Chairman Alan) Greenspan had (been) too accommodative for too long," he said.
Executive's managers also benefited from an increased allocation to mortgage-backed securities, which performed relatively well in 1994.
Among PIPER's rankings of mortgage-backed separate accounts, the median manager returned -1.8%, compared with a return of -1.6% for the Lehman Brothers Mortgage-backed Index.
Mr. Gabriele said Executive's managers invested in straight Government National Mortgage Association securities that were not new issues, called seasoned issues. Structured mortgage-backed securities, collateralized mortgage obligations, have had their problems, while newer issued Ginnie Maes tend to be more volatile, he said. The firm also owned a sizable amount of an Eastman Kodak Co. corporate bond issue that was called in 1994 at prices two to four points higher than where they were trading, he said.
Moreover, the firm's managers stayed away from non-U.S. issues, which they felt were vulnerable to political and economic turmoil, with "better opportunities" found in the United States, he said.
Fleet Investment Advisors' managers shortened the duration of its fixed-income portfolios, as well as focused on high quality, liquid securities, Mr. Thomae said. Fleet's fixed-income composite was the third ranked long duration portfolio in 1994, with a return of -3.6%.
Looking ahead, Fleet's managers see bonds as an attractive alternative to equities. "We think the downside risk is not large when rates are over 8%," Mr. Thomae said. "We are more optimistic than the market in general," with Fleet estimating possible double-digit total returns, and a real return of more than 4% this year.
Executive's managers also are bullish long term on the bond market. Although they see long bond rates topping out perhaps at the 8% or 81/2% yield level, rates could fall below 6% in 1996 or 1997. So its managers are trying to buy on weakness, he Mr. Gabriele said, For example, when long bond rates recently topped 8% for the first time in years, Executive's managers bought zero-coupon Treasury securities to lock in those yields, he said.
Managers at Renaissance are neutral to moderately aggressive on the market, Mr. Anderson said.
In part, he said because "the risk of owning bonds is a lot less than it was last year." With yields this year so much higher than they were last year, there is more coupon cash flow to cushion bond holders if rates should rise sharply again, he said.
Miller Anderson & Sherrerd has also positioned itself a little more aggressively than the market, Mr. Bennett said. Short-term Treasury securities and adjustable-rate mortgage-backed securities look attractive, he said.
"Yields have risen to a level that compensates you adequately for inflation expectations," he said.
PIPER data used for this article were compiled by RogersCasey, Darien, Conn., and may vary from the printed report because of corrections.
