Limited- and intermediate-term bonds barely outperformed longer duration bonds but far outdistanced stocks in the second quarter, according to Pensions & Investments' Performance Evaluation Report results.
The top-performing bond managers in both the PIPER managed and commingled account universes were invested toward the shorter end of the yield curve during the quarter and the 12 months ended June 30, although the return spreads for fixed-income categories were tight from top to bottom.
Rising interest rates pressured overall bond returns as the Federal Reserve raised rates in May for the sixth time in 12 months, resulting in continued inversion of the yield curve. As a result, better returns were found at the shorter end of the curve.
Rising demand for municipal bonds and declining mortgage prepayments helped boost returns in the municipal and mortgage sectors.
The best performing manager in the managed account universe in the second quarter was TranSierra Capital LLC's $101 million Municipal Bond Fund, which gained 4.3%. The TranSierra fund also finished in the top spot for the 12 months and 10 years ended June 30, fourth for the three-year period ended June 30, and third for the five years.
In second place for the quarter was Spectrum Asset Management Inc., Newport Beach, Calif. The Spectrum Unhedged Total Return strategy was up 3.1%, followed by MPI Investment Management, Hinsdale, Ill. MPI's account was up 2.8% in the quarter.
(All returns for periods of more than one year are compound annualized.)
The major story in the second quarter was the increased volatility in the equity market, which hit the skids in April with technology stocks leading the way down. But stock market volatility did little to help bond market returns.
The Salomon Smith Barney road Bond index was up 1.7% in the second quarter, outdistancing the S&P 500 stock index return of
-2.7%. By comparison, the median PIPER managed account was up 1.6% in the second quarter and 4.6% for the 12 months ended June 30. For the year, the Salomon index was up 4.5%. The median managed limited- and intermediate-duration accounts also were up 1.7% for the quarter. For the 12 months ended June 30, the median managed limited-duration account was up 5.2% while the median return for intermediate-duration accounts was 4.5%. Ryan Kelly, principal and chief executive officer at Spectrum, said portfolio managers add value by actively managing the portfolio's duration. "We use an active management strategy and interest rate anticipation. We focus primarily on U.S. government securities," he said. "In 1999, our work said that rates were going up so we sold longer term securities to get shorter, and at the end of the year we started adding to our longer term holdings again."
The short-term fixed-income composite of Capital Consultants Inc., Portland, Ore., finished in the top position among managed limited-duration accounts for the quarter, year and three years, with returns of 2.2%, 6.7% and 7.1%, respectively. The strategy also finished second for the five years with 7%, and fourth for the 10 years at 7.5%.
Roger Thomas, vice president and portfolio manager, said managing duration as interest rates fluctuate is the key to adding value. The actively managed portfolio focuses on overweighting high-quality corporate instruments rated A or higher, while staying away from lower quality debt.
In addition, he said, some clients allow Capital Consultants the latitude to invest in commercial mortgages or a "modest amount" of private investments such a corporate loans and collateral notes linked to receivables whose return is tied to the prime rate. In general, however, Mr. Thomas said the portfolio holds 20% to 25% in U.S. Treasury instruments, 25% in private investments, and the balance in high-grade public debt.
"We pride ourselves on being right on the trend in interest rates," Mr. Thomas said. "We have enough experience to pick up on the trend. We may miss the first 25 basis points turn in either direction, but we recognize when the direction changes and adjust to it."
The short-duration one- to five-year fixed-income composite of Smith, Graham and Co., Houston, returned 1.9% for the quarter, finishing fifth among limited-duration accounts.
Mark Delaney, senior vice president at Smith, Graham, said the short-duration portfolio consists of about 60% corporate bonds and 10% asset-backed securities, with the balance in U.S. government agency issues and Treasuries with an average maturity around 2.8 years.
Stable value on top
Several stable-value funds finished in the top quartile for the quarter and for the year. Stable-value funds resemble limited- and intermediate-term fixed-income funds, with an average maturity generally less than 10 years.
Fiduciary Capital Management's GIC Stable Value Fund returned 6.7% for the 12-months ended June 30, tied for first in the PIPER managed accounts limited-duration category. In addition, the fund was second for the three years with a return of 6.8% and third for the five years ended June 30 also with a return of 6.8%.
Peter Bowles, FCM president, said the fund's long-term performance record is consistent with the firm's disciplined approach and did well despite not having the benefit of capital gains, which benefit traditional fixed-income managers.
Duration management was a significant factor in the fund's performance, he said, as the yield curve flattened and then inverted as rates were trending higher. The fund's duration increased slightly during the 12 months to about 2.8 years from about 2.4 years. He said the fund is made up primarily of traditional insurance company contracts with some synthetic contracts included for diversification purposes.
"For us, we've recognized more value in GICs than some of our competitors, so we didn't make a full-scale rush to synthetics. We do use synthetics for diversification and liquidity purposes at the longer end of the yield curve," Mr. Bowles said.
The story is much the same for the PIPER commingled account universe, where limited- and intermediate-duration funds were the best-performing sectors.
The top-performing commingled fixed-income account in the second quarter was General American Life Insurance Co.'s Private Placement Bond SA Fund, which was up 3%, followed by Columbia Management Co.'s High Yield Fixed Income Fund, which gained 2.9%; and Financial Management Advisors Inc.'s Flexible Income LP Fund and Lipper & Co.'s intermediate bond portfolio, both up 2.8%.
The median commingled fixed-income portfolio gained 1.6% in the second quarter and 4.5% for the year, 5.8% for the three years, and 6.1% for the five years while the median limited-duration bond fund was up 1.7%, 5.1%, 5.7% and 5.9%, respectively, for the same periods.
The median intermediate-duration commingled fixed-income account was up 1.6% for the quarter, 4.3% for the 12 months, 5.7% for the three years and 5.9% for the five years ended June 30.
In the second quarter, the Massachusetts Mutual Life Insurance Co. Short Term Bond Fund returned 1.7%, tied for second among limited-duration commingled fixed-income accounts. In addition, the Massachusetts Mutual fund, managed by David L. Babson & Co., Springfield, Mass., finished third for the 12 months with a return of 54.% and tied for second for the three years, gaining 5.4%. The fund tied for second for the five years, returning 6.3%.
Ronald E. Desautels, managing director at David L. Babson, said the Massachusetts Mutual fund uses a yield preference approach basing its decisions on the shape of the yield curve.
"When the curve is steep, we tend to move out further to a maximum duration of about three years; when it is inverted, we target the shorter end of the duration scale," said Mr. Desautels. Fund managers use a sliding duration scale of up to three years, he said.
He said the fund ended the period quarter with about one-third of its assets invested in corporate securities, one-third in Treasury instruments, and another third in a combination of mortgage-backed securities, government agency securities, asset-backed securities and commercial paper. The largest sector allocation shift occurred earlier this year, he said, when the fund moved from about 43% invested in Treasury securities to 3%, and agencies were boosted to about 14% from 3%.
"We started the year with some six- to seven-year Treasury exposure and as the yield curve inverted we did well. With the increased volatility in the market early in the year, we relocated to agencies to take advantage of the extra yield," said Mr. Desautels.
First Merchant Bank NA, Muncie, Ind., finished the quarter with two funds in the top 10 of the PIPER commingled fund intermediate duration universe. Its Intermediate Employee Benefits Fund ranked second with a return of 2% and its Intermediate Personal Trust Fund tied for fourth with a return of 1.8%. The First Merchants funds finished in the top five in the one- and five-year periods, and in the top 15 for the three- and 10-year periods.
Both funds have similar management styles, said Mark Collison, chef investment officer. "Both are focused on the corporate market, which is even more amazing since that is a sector that has hurt us on occasion," he said.
The funds are about 80% corporate securities and 20% U.S. Treasuries and agencies. Each is invested in high-quality securities that "tend to mirror the benchmark (Lehman Brothers Intermediate Government/Corporate index) with an average maturity of about 4.3 years."
He said the funds' long-term performance record is attributable to a combination of deft duration management and securities selection.