The 697-basis-point gap between the best- and worst-performing core bond managers for the year ended June 30 was unprecedented, consultants say.
In addition, most suffered atrocious second-quarter performance, in large part because the collapse of WorldCom Inc. so severely affected the whole corporate bond sector.
A 200- to 300-basis-point difference for bond managers in the same investment style is not too unusual for a quarter or 12 months. Such return dispersion tends to be exhibited by a fairly small number of money managers in a given universe, with the performance gap narrowing over longer time periods.
But June 30 brought an entirely different scenario, one with wider gaps between manager returns than anyone is used to. Data from Pensions & Investments' Portfolio Evaluation Report quantified the performance gap.
According to PIPER, the composite returns of institutional broad-market bond portfolios in the 95th percentile of the universe for the second quarter were 474 basis points below those managers in the 5th percentile. The gap for the year ended June 30 was even bigger - 697 basis points.
The gap narrowed for longer periods: to 308 basis points for the three years ended June 30, to 212 basis points for five years and to 164 basis points over 10 years.
Dispersion also was unusually high in the universe of institutional core-plus bond managers, which can include high-yield bonds in the portfolio, according to data from InvestWorks.com, the manager database of consultant CRA RogersCasey, Darien, Conn. There was a 695-basis-point difference between the performance of core-plus bond managers in the 5th percentile vs. the 95th percentile as of June 30, compared with a 417-basis-point difference a year earlier.
Normally, bond manager returns are so tightly clustered on a scatter chart that one "can barely make out space between the lines," said Jeffrey Nipp, director of investment management research, Watson Wyatt Investment Consulting, Atlanta.
Monte Tarbox, vice president and director of consulting operations at Independent Fiduciary Services Inc., Washington, agreed. "There's usually a fairly uniform dispersion around the median, but the difference at the end of June was unusually wide."
As for performance, Mr. Nipp said many bond managers lagged "several hundred basis points behind the Lehman Aggregate" index in June. "We've never seen damage like this before ... These kinds of numbers are unfathomable."
Rich Ranallo, senior vice president in the Cleveland office of Segal Advisers, said: "This kind of performance is literally an unmitigated disaster, a train wreck. They just gave up four years of performance."
Much of the blame rests with the June bankruptcy of WorldCom, which shook the corporate bond market and especially damaged high-yield bonds.
"In a word, it was WorldCom," said Mr. Nipp. "It took down the whole telecommunications sector and it really, really hurt managers."
"When a manager does poorly and underperforms the benchmark by several hundred basis points ... it magnifies the pain that sponsors are already feeling. They use fixed income to dampen volatility of their portfolios and when problems like this happen, it calls into the question the very role of fixed income in a portfolio," said Richard M. Goldman, managing director, Deutsche Asset Management in the Americas, New York.
Part of the difficulty for core bond managers is that the index to which most clients compare them - the Lehman Brothers Aggregate - is extremely diverse, with 5,000 to 6,000 holdings, said Segal's Mr. Ranallo. As a result, the impact of any one single corporate bond, such as WorldCom, is diminished.
Most corporate bond managers, he said, are much less diversified, so even a 1% or 3% bond stake in a corporation that collapses would be a severe drag on performance.
Core-plus bond managers, even those with a comparatively moderate 5% to 10% high-yield weighting, also were smashed as the market fled to the highest quality bonds it could find, Mr. Ranallo said.
To make matters worse, WorldCom was dropped from the Lehman Aggregate in May, which greatly helped the performance of the index, but further hurt money managers.
Indeed, Mr. Ranallo noted the 3.79% year-to-date June 30 return of the Lehman Aggregate would place it in the first quartile among institutional broad market bond managers.
When WorldCom declared bankruptcy at the end of June, many managers were stuck with big chunks of almost worthless bonds. And, failure to sell bad bonds when they could continues to haunt money managers.
"There is no-sell discipline when bonds get downgraded. Everyone just holds on, hoping for a snap back. In this business, it's OK to be wrong, apparently, as long as everyone else is," said bond manager Jeffrey Gundlach, a group managing director at TCW Group Inc., Los Angeles. Mr. Gundlach manages about $35 billion in bond portfolios with an emphasis on mortgages, which did not suffer badly from corporate bond meltdowns.
IFS' Mr. Tarbox said bond manager assessment has become "the hardest I've ever experienced. It is extremely difficult to determine who is really getting it right and whether that's due to skill or luck or whatever. The impact of style right now is profound."
Added Mr. Ranallo: "Money managers have explained their results very well. But it's very difficult for a consultant to say, `This underperformance is OK, because it was due to WorldCom or one of 10 bonds that did poorly, because you couldn't predict fraud,' and then to say, `But this underperformance over here is not okay.'
"I can't play that role ... If a manager is not up to the level they should be after a reasonable period of time, they are gone," Mr. Ranallo said.