Long bond portfolios were king in the third quarter.
Domestic and international fixed-income investors of different disciplines experienced positive returns in the third quarter, driven chiefly by cuts in interest rates. Meanwhile, domestic and international equity investors took it on the chin, according to Pensions & Investments' Performance Evaluation Report.
In the third quarter, the median return in the managed fixed-income universe was 4.4%, a marked improvement from the previous quarter, when the median return was 0.7%. The Salomon Broad Bond Index returned 4.7% in the third quarter.
In comparison, the median return for an equity account in the quarter was -15%. Over a 10-year span, however, the median returns for equity managed accounts still outshine those of fixed income.
The outperformance of fixed income might be fleeting. Bond managers "have been pleasantly surprised," John Chalker, managing director of LM Capital Management Inc., San Diego, said of the performance of bonds this year. However, he added that interest rates, now at 2%, can only go to zero.
"We believe equities will outperform bonds over time," said Bill Mahoney, director of business development at Bridgewater Associates Inc., Westport, Conn.
Bridgewater's $300 million extra-long duration bond strategy was the top performer among separately managed domestic fixed-income portfolios in the third quarter, with a 13.7% return. "It has a high sensitivity duration," said Mr. Mahoney, explaining the account performs very well as interest rates go down, and it served as a good deflationary hedge in the third quarter.
The long-term discipline of the account, along with security selection, led to strong returns. In the 10 years ended Sept. 30, the extra-long duration strategy also was the top performing fixed-income account in the PIPER managed fixed-income universe with an 18% annualized return. In addition, the strategy had annualized returns of 25.5% and 21.8% in the one- and five-year periods ended Sept. 30, besting all other fixed-income managers.
PIPER fixed-income managed accounts were competitive with well-known fixed-income benchmarks over longer periods of time. The median annualized returns for fixed-income managed accounts overall in the one-, three-, five, and 10-year periods ended Sept. 30 were 12.7%, 6.5%, 7.9%, and 7.8% respectively. The median annualized returns for Salomon Broad Bond Index were 13.1%, 6.4%, 8.1%, and 7.8% for the one-, three-, five, and 10-year periods ended Sept. 30. The median annualized returns for 90 Day Treasury Bills were 5.0%, 5.1%, 5.2%, and 4.8% for the one-, three-, five, and 10-year periods ended Sept. 30.
Four of the top five overall domestic fixed-income managed accounts in the third quarter were long duration strategies. Besides top-ranked Bridgewater, the others were: Pacific Investment Management Co. long-duration fixed, 8.1%; S E B Asset Management America Inc. long-duration government, 7.7%; and Jennison Associates LLC active extra long fixed income, 7.5%.
The only exception among the top five was PanAgora Asset Management Inc.'s active core strategy, with a 7.7% rate of return.
Long-duration fixed-income strategies appeared to be a good fit for pension funds in the third quarter and over longer periods of time. "I think it is a really good area for institutional investors who are trying to get a good match between investments and liabilities," said Ken Leech, chief investment officer of Western Asset Management Co., Pasadena, Calif. His firm's long duration strategy, with about $5 billion in assets, ranked seventh in the asset style for the third quarter with a 6.7% return.
The duration of Western's portfolio was slightly longer than the benchmark, the Lehman Brothers Government/Corporate Bond Index, benefiting the fund in the third quarter. "In general, our preference was to be mildly longer than the market," said Mr. Leech. Another benefit to the strategy was its exposure to zero-coupon Treasuries, he added.
Western portfolio managers used similar strategies to their benefit over the long term. As a result the strategy has placed in the top five of long-duration fixed-income accounts in the one-, three-, five-, and 10-year periods through Sept. 30.
Intermediate duration fixed income accounts also performed well in the third quarter with the median return for managed accounts in the asset style being 4.6%, only 23 basis points below the median return for long duration fixed-income managed accounts. The top five performing intermediate fixed-income accounts for the third quarter were: S E B Asset's Intermediate Government/Corporate, 5.8%; Weaver C. Barksdale & Associates' Intermediate Fixed Income, 5.6%; Allegiance Capital Inc.'s Intermediate Duration, 5.5%; PIMCO Moderate Duration-Full, 5.4%; and City Capital Inc. Intermediate Fixed Income, 5.3%.
LM's $150 million intermediate-term fixed account was the 10th highest performing intermediate domestic fixed-income strategy in the third quarter, returning 5.2%. It also had the third and fifth highest returns among intermediate strategies for the three- and 10-year periods ended Sept. 30, with 7.7% and 8.1%, respectively.
The LM account is slightly longer in average duration than its benchmark, which is the Lehman Brothers Intermediate Government Corporate index. "We have a long-term bias," Mr. Chalker said. The portfolio, which only holds 30 securities, had an average duration of 3.9 years in the third quarter vs. 3.7 for the index. The portfolio is underweight in U.S. Treasuries and overweight in agencies and corporate securities, he said.
"We have no plans right now to make any changes to general portfolio characteristics," said Mr. Chalker.
In broad-market strategies, only five accounts out of 251 in the PIPER broad-market fixed-income universe registered negative returns in the third quarter. The style also performed very well in the long term. In the three-, five, and 10-year period ended Sept. 30, the median PIPER broad-market return was 6.3%, 8.2% and 8.1%, respectively.
The top five performing accounts in the style were: PanAgora Asset Management Fixed Income Active Core, 7.7%; S E B Asset Management aggregate duration, 7.2%; Redstone Advisors Active Duration Fixed Income, 6.5%; Essex Investment Management Active Fixed Income, 6.2%; and PIMCO Total Return Fixed Income-Full, 6.1%.
"We share our strategies and expectations with our clients so they let us run with a long leash," said Anders Ekernas, S E B president and chief investment officer. The $362 million Aggregate Duration portfolio he manages has been one of the top 15 performing broad-market fixed-income accounts in the one-, five-, and 10-year periods prior to Sept. 30.
The success of the portfolio can be attributed to three factors this past quarter, said Mr. Ekernas. The first is S E B's credit risk. The portfolio does not own any bonds with ratings lower than AAA. Also, the portfolio's duration was higher than that of its benchmark, the Lehman Brothers Government Bond index. Also, because clients give S E B a lot of freedom, the allocation can be shifted "opportunistically," said Mr. Ekernas. As an example, he mentioned a recent switch in which S E B lowered its ownership of bonds with maturity rates of eight to nine years and increased ownership of bonds with four to five year maturity rates.
"From time to time, we are wrong," said Mr. Ekernas. "You need a higher degree of conviction when you are right."
Despite its diminishing popularity among U.S. investors, non-U.S. bond portfolios pulled in competitive returns in the third quarter and over the long-term. The median international fixed-income return was 7.3% in the third quarter.The median annualized returns for international fixed-income managed accounts in the one-, three-, five, and 10-year periods ended Sept. 30 were 5.6%, -0.7%, 2.3%, and 7%, respectively.
The top performing international fixed-income account was the Strong Capital Management Inc. international fixed income account, which returned 10.1% in the quarter.
One of the consistently top returners in the asset class is the Dublin-based $75 million Bank of Ireland Asset Management's international fixed-income account. The portfolio returned 8.5% in the third quarter and 8.1% in the one-year period. In addition, the portfolio returned 2.8% in the five years and 7.5% in the 10-year period.
The Bank of Ireland account beat its benchmark, the J.P. Morgan non-U.S. World Government bond index by 660 basis points in the third quarter. The portfolio benefited from an underweighting to Japanese bonds and an overweighting to European bloc countries, said Ronan O'Donoghue, director of fixed-income. The portfolio also had a slightly longer duration than its index, he added.
"We have been in an environment that has been bullish on bonds," said Mr. O'Donoghue of the long-term success of the strategy. Bank of Ireland has stayed away from emerging markets and any market its portfolio managers consider illiquid, he added. In addition, the portfolio's minimum credit rating for a security is AA, he added.
The State Street Research Global Fixed account was the top performing managed global fixed-income account in the third quarter with an 8.3% return. The median return for managed accounts in the same asset style was 6.9% in the third quarter.
Among commingled fixed-income funds, Barclays Global Investors, San Francisco, and Northern Trust Global Investments, Chicago, dominated the top five overall fixed-income category.
BGI's long government bond index and 20+ Treasury index funds returned 6.8% and 6.7%, respectively, to place first and third. NTGI's monthly long-term government bond and monthly intermediate government bond funds returned 6.8% and 6.3% respectively, placing second and fourth. Finishing the top five was Oppenheimer Capital's total return fund, with 5.9%.
The median return for commingled fixed-income funds in the third quarter was 4.5%. The median annualized returns for commingled fixed-income funds in the one-, three-, five, and 10-year periods ended Sept. 30 were 13.1%, 6.4%, 7.7%, and 7.8% respectively.
Over longer periods of time, the fixed-income fund of Provident Mutual Life Insurance Co., Wilmington, Del., proved to be the most consistent high performer in the commingled universe. The fund had annualized returns of 18.1% and 13.3% in the three- and five-year periods ended Sept. 30. The fund also had an annualized return of 10.1% in the 10-year period ended Sept. 30, ranking third for that horizon.