Long-term Treasuries flourished while high-yield bond funds faltered in the first quarter, according to Pensions & Investments' Performance Evaluation Report data.
The top managers in both the commingled fund and managed account universes invested primarily in long-term Treasury and government bonds funds.
"We saw sentiment change," said Brad Adams, senior vice president and director of fixed income at Northern Trust Quantitative Advisors, Chicago. "The Treasury sector performed well, and the longer end did the best."
The NTQA Long Term Government Bond Fund returned 7.7% in the quarter ended March 31, placing it second on the PIPER list of commingled fixed-income funds. For the 12-month period, the fund didn't do as well, returning 0.31%, but for three years it was second with 9.95%. (All returns for periods of more than one year are compound annualized.)
The top commingled fund performer on the first-quarter list, the Barclays Global Investors 20+ Treasury Bond Index Fund, returned 9.4%, while BGI's Long Term Government Bond Index Fund ranked third with a return of 7.7%. These funds remained in the first and third positions for the three-year period ended March 31 with returns of 10.7% and 9.9%, respectively.
By comparison, the Lehman Brothers Government/Corporate Long Term Bond index posted a return of 5.6% in the first quarter while the Lehman Brothers Treasury Bond index returned 3.8%. The median PIPER commingled fixed-income fund returned 1.7% for the quarter, 2.1% for the year and 6.4% for the three years.
The strong performance of the long-term Treasury sector primarily was driven by the government's launch in January of a program in which it will use surplus money to buy back long-term debt. As a result, the sector outperformed all others, including short- and intermediate-term Treasuries.
"We haven't seen a picture like that since the third quarter of 1998," said Marianne Feeley, consultant with William M. Mercer, Chicago. "Fed tightening combined with this reduction in supply really resulted in the inversion of the yield curve."
High-yield funds, which along with short-term Treasury bills were the top performers last year, were among the worst performers in the first quarter. The Salomon High Yield index returned just -2.6% for the first quarter and no high-yield funds cracked the top 15 in either the commingled or managed fixed-income universes.
In comparison, the Salomon High-Yield Index returned 1.7% in 1999. For the three-and five-year periods ended March 31, it posted a return of 4.6% and 7.9% respectively.
"High-yield bonds have really fallen off a cliff this year," said Diane Vazza, head of global fixed-income research at Standard & Poor's Corp., New York.
The high-yield sector's first-quarter woes are due primarily to volatility in the interest rate environment, which may continue as more rate hikes are anticipated in 2000.
In the corporate bond world, managers that invest in investment-grade bonds have had more success in 2000. But high-quality issues are getting harder to find. In the first quarter, S&P downgraded 109 corporate bonds and upgraded just 30.
Loomis Sayles & Co., Boston, occupied the fourth and fifth spots on the PIPER list of the top commingled fixed-income funds for the quarter. With a return of 4.4%, the Loomis Sayles FIM: Investment Grade Fund was the top-performing investment-grade fund on the list. The firm's FIM: Fixed Income Fund, with a return of 3.8%, placed fifth on the list. For the one-, and three-year periods ended March 31 the Fixed Income Fund returned 4.6% and 7.9%, respectively, ranking 12th and seventh.
The Fixed Income Fund differs from the Investment Grade Fund in that it invests up to 35% of its portfolio in high-yield bonds, said Kathleen Gaffney, vice president of the fixed-income management group at Loomis Sayles, but the strategies are essentially the same.
"We're bond pickers," she said. "It's very analogous to value equity in that we're really looking for good values with positive fundamentals."
The first quarter was a continuation of the success the funds had in 1999, which in turn was a result of the buying the team did during the volatile summer of 1998, she said.
The investment-grade fund benefited from Canadian holdings because the Canadian dollar did well in the first quarter, said Ms. Gaffney. The fixed-income fund took advantage of high-yield credits that performed better than other high-yield issues in the first quarter, particularly telecommunications, emerging markets and technology issues.
"We don't tend to be where the mainstream market is," said Ms. Gaffney, which might explain why the high-yield portion of the portfolio returned 4%. Many of the best-performing technology issues in the first quarter were convertibles, which they bought in 1998 instead of typical high-yield issues. "Being opportunistic and buying into some of the uncertainty back in 1998 really paid off," she said.
The PIPER list of managed fixed-income accounts also saw a changing of the guard from high-yield funds to long-duration funds that focused primarily on government issues.
The top-performing managed account was the Extra Long Duration Bond strategy offered by Bridgewater Associates Inc., Westport, Conn. The account had a first-quarter return of 14.4%. For the one-year period ended March 31 that account was third from the bottom with a return of -6.1%, but on top for the three-, and five-year periods with returns of 26.7% and 25.4% respectively.
The median PIPER managed fixed income accounts for the periods were 1.8% for the quarter, 2.1% for the year, 6.5% for the three years and 8.1% for the five years.
Second on the list was the Fixed Income Composite of Hoisington Investment Management Co., Austin, Texas. The strategy, which returned 12.5% in the first quarter, invests only in U.S. Treasuries. The change in performance is "more of a change in psychology than anything else," said Lacy Hunt, executive vice president at Hoisington. "Last year, the psychology focused on the negatives with regard to the bond market. Then in the first quarter it focused on the positives."
Last year, he said, the federal budget situation was just as favorable and with a record surplus it was apparent the Treasury would engage in a buyback program. But, he said, "the market chose last year to focus on the notion that the strong real economic growth was going to produce higher inflation and higher interest rates."
The Fixed Income Composite strategy is flexible in that it may include Treasuries of all durations. In the latter part of 1999, the management team took steps to extend the average maturity of the portfolio on the notion that the multiyear fundamentals are favorable to the bond market.
"We're constantly looking at the macroeconomic picture," said Mr. Hunt, to determine the right duration in which to be invested. The firm charts more than 500 economic indicators and keeps a close eye on inflation. "When the multiyear trend in inflation is downward, you can expect we're going to be positioned in bonds" as opposed to Treasury bills.
Third on the list with a return of 11.3% for the quarter was the Long Duration Fixed Income portfolio run by Barrow, Hanley, Mewhinney & Strauss Inc., Dallas. NISA Investment Advisors' Long Duration Fixed Income portfolio and SEB Asset Management Inc.'s Long Duration Government portfolio placed fourth and fifth with returns of 11.1% and 10.6%, respectively.
While none of the top five cracked the top 15 for the 12 months ended March 31, the names dominate the three-, and five-year lists.
Among managed broad market fixed-income funds the Active Duration Fixed Income portfolio managed by Redstone Advisors Inc., Wichita, Kan., had the best first-quarter return, with 8%, followed by the Peregrine Capital Management Positive Return Fixed Income portfolio, with 6.2%; the SEB Aggregate Duration portfolio, 4.6%; and the Fiduciary Asset Management Co. Structured Core Fixed Income portfolio, 4.2%.
Fifth in the category was the Active Duration portfolio managed by Fleet Investment Advisors, Boston. The team managed fund, which invests in Treasuries and high-quality investment-grade bonds, posted a 3.7% return in the first quarter.
Glenn Migliozzi, managing director of fixed income, said the fund looks to take advantage of changes in interest rates. The firm decided to buy long-term Treasury bonds last summer, anticipating that the yield curve was going to flatten.
"We were a little early," said Mr. Migliozzi, but the move paid off in the first quarter.
"Owning lots of Treasury bonds seems kind of boring, but they're making less of them and the U.S. Treasury is buying them back."