SAN FRANCISCO -- Style diversification typically has been a subject for equity investors, but now Barclays Global Investors has come up with a way to apply it to core domestic bond portfolios.
By making many small bets on 74 microsectors of the Lehman Aggregate Bond index, San Francisco-based BGI hopes to produce excess returns of 75 basis points a year while maintaining a low correlation to traditional core bond strategies.
BGI already has pulled in more than $400 million for its new strategy from an unnamed institutional client, and officials say other big pension funds are expressing interest. The manager plans to unveil this summer a second fund benchmarked to the Lehman Universal index.
Outside benchmark
Leading bond managers have picked up excess returns from buying securities outside the benchmark, such as high-yield or emerging-market debt, or by making interest rate or yield bets, BGI officials said.
When bond managers hold a chunk of the portfolio -- often 10% -- in non-benchmark credit risks, they call it "a tactical asset allocation," said Thomas Sponholtz, head of fixed-income product development. But it looks more like a strategic allocation when the managers have had the exposure for the past 10 years, he said.
That's how BGI managers think they can add something new to the mix. Their CoreActive Bond strategy, which is effectively duration neutral and tends to be spread duration neutral, provides returns comparable to those of core products but with lower correlations in periods of greater volatility.
Mr. Sponholtz said the top 10 bond managers, as a group, returned -97 basis points against the benchmark in the volatile third quarter of 1997, while backtesting shows BGI's strategy experienced an eight basis point relative gain.
Conversely, when core bond managers provided 45 basis points in excess returns in the third quarter of 1995, the BGI strategy was up 20 basis points.
The BGI figures are based solely on backtesting its microsector allocation approach, comprising about two-thirds of alpha, noted Prahu Palani, fixed-income product manager. Potential gains from stockpicking are not included because they are difficult to backtest.
Correlations
What's more, while core active bond managers were correlated at just below 0.3 against each other in a normal bond market, those correlations headed toward 1.0 in a more volatile environment, Mr. Sponholtz added.
Some fixed-income experts believe BGI's claims of making 75 basis points annually are overblown. While favoring the product, one consultant, who asked not to be named, said: "25, 50 I could see, but I think 75 is a little high."
Another bond expert, who also requested anonymity, called BGI's claims as "hype." He said 80% to 90% of core bond managers' returns stem from duration bets, while only 5% to 10% come from credit issues.
