BOSTON -- There are two ways to tell that opportunistic fixed-income investing is becoming a common practice in the industry:
First, consultants are looking for a consistent, recognizable name for the approach. And second, Lehman Brothers is launching a new investible bond index that could evolve into a benchmark for the strategy.
Pension funds and other tax-exempt institutional investors have demonstrated they are willing to expand the boundaries of traditional core fixed-income investing if it means more yield with minimal added risk. An opportunistic fixed-income investor reaches beyond traditional core asset selections for small, timely opportunities.
Callan Associates Inc., San Francisco, illustrates the difference between core and opportunistic fixed-income investing this way: A typical median core exposure may include about 40% Treasury, 21% investment grade, 29% agency pass-through, 3% U.S. agency, 2% U.S. denominated, 1% agency collateralized mortgage obligation, and 4% asset-backed securities.
A median core exposure with opportunistic allocations -- which Callan calls Core Plus -- would include about 13% high-yield bonds and 5% non-U.S. denominated investments, two things not traditionally found in domestic core portfolios.
With high-yield and overseas investments comes more risk, which is why both styles were not part of traditional core profiles. But managers who have added these sectors have found they can gain performance without significantly more volatility, according to Callan.
The Core Plus allocation also could include about 29% Treasury, 26% agency pass-through, 5% U.S. denominated, 1% agency CMO and 2% asset-backed securities.
Bond investors have especially been drawn to non-U.S. dollar investments in the world's emerging markets and Europe, where changes are providing new opportunities and the possibility of high yields.
When the domestic investment mandate allows discretionary active management, bond managers have been delving into domestic high-yield, Brady bonds, sovereign debt, British gilts and Japanese government bonds.
"In the early 1990s, our portfolios were fully invested in U.S. issuers. Now it's only about 80%," said Kathleen Gaffney, vice president and portfolio manager of the fixed-income group at Loomis, Sayles & Co. LP, Boston.
Loomis Sayles began investing in Brady bonds and exploring opportunities in Europe several years ago. Loomis' fixed-income group manages $28 billion, predominantly institutional assets.
"Last year, Asia got our attention," Ms. Gaffney said. "The Brady market has gotten more efficient, so we've been making comparisons between Brady debt and sovereign global debt."
"Managers can stick to the Lehman Aggregate (Bond index) and earn a pretty safe return," said David Brief, a consultant with Ennis, Knupp & Associates, Chicago.
"But they want to expand their horizons and are willing to take risk. Even though bonds are supposed to be more conservative than stocks, there's no reason to leave money on the table. If you can earn more on a bond portfolio without greatly increasing risk, it's a reasonable thing to do."
At Ennis, Knupp, opportunistic bond investing is called a "global fixed-income opportunity."
The median core bond manager has outperformed the traditional benchmarks by only about 20 basis points on average for the past decade, according to Callan.
"It's been difficult to add value with core, and harder to beat the market," said Jason Windawi, a consultant with Callan. "It's natural that managers are searching for more."
Mr. Brief said not every manager is equipped to handle expanded core investing. Pension fund executives need to evaluate a firm's resources and expertise, and consider the manager's experience, he said.
And managers that expand their bond investing not only face the risk of market volatility, but also risk being different from current benchmarks, he said.
The world bond market involves about $21 trillion, said Jack Malbey, chief global fixed-income strategist for Lehman Brothers, New York. But current global bond indexes don't measure the entire universe. For example, the Lehman Aggregate Bond index measures only about $5 trillion of the $21 trillion market, he said.
That's why Lehman Brothers is creating a new universal bond index that could be ready by the end of this year. It would include much of what is in the Lehman Aggregate: investment-grade corporate bonds; U.S. agency bonds; mortgage-backed securities; and U.S. Treasuries. But it would add such vehicles as private placements and emerging markets in the credit sectors, and non-U.S. government securities.
"The universal index is a logical extension of the same development in the industry. We're trying to capture valuation change across global financial markets. We still have a couple of decisions to make yet, but it will be a sum total of most of our indexes," Mr. Malbey said.
Loomis Sayles' Ms. Gaffney said some clients are ready to step into the domestic high-yield market because they've seen the returns. Other clients are hesitant about the volatility.
"It takes courage to enter a new market. Because the cycle has been so short, the risk-reward hasn't really borne out yet," Ms. Gaffney said.
"There is less value in the U.S. and you are not getting paid to take that credit risk. Better values are found elsewhere," Ms. Gaffney said.
Composite returns for Loomis' high-yield investments for the year ended Dec. 31, were 16.07% vs. 12.83% for the benchmark, the Merrill Lynch High Yield index. Loomis' medium-grade composite returns for 1997 were 13.94%, compared with 9.76% for the Lehman Government/Corporate index benchmark.
PanAgora Asset Management, Boston, has developed a Global Enhanced Bond Management model that forecasts returns in the world government bond index universe relative to returns in the U.S. bond market.
"It's a question of which countries are going to do well, or poorly, next month relative to the U.S.," said Jan Faller, a PanAgora fixed-income portfolio manager. "You can't tie a manager's hands to only manage domestics. The manager has to have the ability to rotate opportunistically. That's how you diversify the interest rate risk in the United States."
PanAgora does not invest in emerging markets, but focuses on Europe and developed Asian markets.
Results for PanAgora's enhanced style were 10.56% for the year ended Dec. 31, compared with 9.68% for the Lehman Aggregate bond index,
PanAgora manages $3 billion in fixed income and about $125 million in the strategy that includes opportunistic international against a domestic benchmark.