Managers sticking with short durations dominated the rankings of the Pensions & Investments Performance Evaluation Report during the first quarter.
Most of the top 10 performing fixed-income accounts for the quarter ended March 31 were short- to intermediate-duration portfolios.
Looking ahead to the second quarter, many managers were taking a mixed to neutral stance on interest rates, seeing a slight short-term inflationary pressure following rising oil prices. They also expect higher commodity prices due to the ongoing drought in parts of the country. Because of those pressures, they see interest rates rising or at least holding, which will favor shorter durations in the short term.
The fixed-income portfolio of FXC Investors Corp., Glendale, N.Y., was the top performer for the quarter and the year, and was third in the three-year period. It returned 5.2% for the quarter, 28.6% for the year and 10.8% for the three-year period. The positive return fixed-income portfolio from Peregrine Capital Management, Minneapolis, was the top performer in the three-year period with 10.9%, and the managed bond portfolio from Bell Capital Management, was first in the five-year period. All returns of more than one year are compound-annualized.
Dana Investment Advisors, Brookfield, Wis., had two of the top 10 portfolios for the quarter. Its short-duration portfolio was the top limited-duration account and the second-place portfolio overall for the quarter, with 2.1%, while its short/intermediate duration portfolio was third among short-duration accounts and fifth overall, returning 1.8%. The short-duration portfolio was seventh and sixth among short accounts for the year and three-year periods, with returns of 9.7% and 6.2%, respectively.
Managing duration aids success
Managing duration was part of the successful strategy that helped Dana Investment achieve good performance for the quarter, said Jim Ivey, executive vice president and head of the firm's investments department. Dana's portfolio uses adjustable rate securities and varies their weightings depending on the interest rate environment. Individual portfolio duration varies according to the client's risk/reward parameters, said Mr. Ivey.
Dana Investment invests in pools of Small Business Administration loans and mortgages pooled by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. Coupons on the SBA loans adjust according to the current interest rates monthly or quarterly, while the mortgages are indexed to three- and five-year Treasuries.
If rates are going up, the portfolio increases its weighting to the SBA pools, whose coupons will adjust upward quickly; if rates are headed down, it moves to mortgages, which will adjust downward at a slower rate.
"The basic philosophy is the same. It's just an extension of the duration to achieve more yield," said Mr. Ivey.
As for the rest of the year, "we're just starting to get a little nervousness about inflation, especially with the drought .... which will impact commodity prices and the Consumer Price Index," said Mr. Ivey. Additionally, the price of oil is expected to rise to $25 to $26 per barrel (West Texas crude has been trading at $21-$22 per barrel recently) so the economy will see some inflationary forces that will preclude the Federal Reserve Board from lowering interest rates, he said.
However, Mr. Ivey added he doesn't see a long-term upward trend in rates. The signals are mixed at the moment, so managers can hedge by balancing portfolios between the short and long end, he said.
Good calls outside the U.S.
The medium grade fixed-income composite portfolio of Boston-based Loomis, Sayles & Co. was second in the one- and three-year periods and third for five years, with returns of 20.4%, 10.9% and 13.6%, respectively. The portfolio, a composite of 48 accounts representing $4.9 billion in assets, was also the top broad market performer for the year and second in the three- and five-year periods.
The portfolio made some good calls in markets outside the United States. It also benefited from a year-long sell-off of convertible securities, said Dan Fuss, executive vice president.
The Loomis, Sayles portfolio invests outside the United States opportunistically rather than for diversification, said Mr. Fuss. The portfolio has had an average weighting of about 17% in Canadian provincial and federal debt, where spreads have narrowed in recent months against the U.S. debt market by about 100 basis points. It also has some holdings in New Zealand government debt and Irish government debt, as well as significant holdings in Brady bonds, which have performed well, said Mr. Fuss.
Mr. Fuss said he also had some significant holdings in "busted convertibles" - convertible bonds trading on their merits instead of their convertibility - which have performed well. The sector now is underweighted because in the past year many of the positions were sold in profit-taking and others were converted to stock.
"It's a nice time of the credit cycle. The economy has been strong (and) the credit companies have been reviewing on regular basis," he said.
Mr. Fuss said he is starting to go back into U.S. Treasuries, which are cheap now; 28-year Treasury bonds now make up 7% to 8% of his portfolio. It was good to own corporate debt when the spreads against Treasuries were narrowing, but now they've narrowed so much there is little to gain by owning them over the foreign bonds or U.S. bonds, he said.
Mr. Fuss noted some indicators - like the performance of convertibles and commodity prices -seem to say it's late in the business cycle.
He noted the last time he was so light in convertibles was spring-summer 1987, although he warned about making too much of that indicator. Most of the commodity activity doesn't signal higher inflation and, although it may be late in the business cycle in United States, it is still early elsewhere, he noted.
"Right now - as it has been for some time, quite a long time - there are no major stresses," said Mr. Fuss. "If I were really bearish on things I would not be buying 28-year bonds."
For intermediate duration, the active intermediate management portfolio from Gabelli-O'Connor Fixed Income Management Co., Darien, Conn. was the top quarterly performer and was seventh among all portfolios for the quarter, with 1.3%. The top one-year performer was the fixed-income plus portfolio from Spectrum Asset Management Inc., Newport Beach, Calif., with 14.4%. The Spectrum portfolio also was second and fifth in the three- and five-year periods, respectively.
By comparison, the Lehman Brothers Intermediate Bond Index returned -0.8% for the quarter, 9.6% for the year, 5.5% for the three years and 7.9% for the five years.
The top long-duration portfolio for the quarter, the value income portfolio from Llama Asset Management Co., Fayetteville, Ark., was alone in showing a positive return for the quarter, with 0.04%. The other portfolios in the long-duration top 10 all showed returns ranging from -1.4% to -5%. By comparison, the Salomon Brothers Long-Term High-Grade Bond Index returned -4.9%.
Penn Capital Management, Cherry Hill, N.J., was the top performing high-yield bond manager for all periods. Its portfolio returned 7.1% for the quarter, 26.3% for the year, 17.7% for the three-year period and 26.5% for the five-year period ended March 31. The Salomon Brothers High Yield Bond Index returned 1.7% for the quarter, 15% for the year, 10% for the three years and 14.7% for the five-year period.
Defensive allocation
The stronger economy and issue selection helped Penn Capital, said Richard Hocker, chief investment officer. It has benefited from the successful bankruptcy reorganizations of companies such as USG Corp., National Gypsum Co. and R.H. Macy & Co., as well as from turnarounds at underperforming companies.
The firm uses a defensive allocation, putting 50% of its portfolio in a core of B-rated debt, considering BB-rated bonds too sensitive to interest rates, said Mr. Hocker. Around that core, it allocates 20% to distressed debt and 30% to a rotational component that trades in underperforming debt of solvent companies much like value equity investors trade in and out of stocks.
Among the rotational issues that scored well for Penn: Mosler Inc., a bank equipment supplier that underwent streamlining under new management; and Drypers Corp., a disposable diaper manufacturer hit by last year's increases in paper prices and a price war between larger competitors Kimberly-Clark Corp. and Procter & Gamble.
High-yield bonds benefit in the current climate because the market is being driven by short maturities and is affected more by credit risk than by interest rate risk, said Mr. Hocker.
He noted the average maturity in the high-yield universe is 6.5 to seven years.
The top performing mortgage-backed securities portfolio was Commercial Mortgage SA 6 from General American Life Insurance Co., St. Louis, which returned 2.1% for the quarter. That portfolio also was the top performer for the three-year period, with 9.1%.
Trust Co. of the West, Los Angeles, had three of the top 10 mortgage-backed portfolios for the quarter in second, third and sixth place. One of them, the mortgage-backed securities portfolio, was the top performer for the year, with 13.9%. By comparison, the Lehman Brothers Mortgage Index returned -1.2% for the quarter, 8.4% for the year and 6% for the three-year period.
The median return for managed fixed-income accounts in the PIPER universe was -1.3% for the quarter, 10.3% for one year, 5.9% for three years and 8.7% for five years. By comparison, the Salomon Broad Bond Index returned -1.7% for the quarter, 10.9% for the year, 6.1% for the three years and 8.6% for the five-year period.
The PIPER numbers are calculated by RogersCasey, Darien, Conn.
