"This has led plan sponsors today to do two things. First, they are saying to themselves, ‘If active managers are not adding value, why not just index and do some securities lending to reduce fees.'
"The second thing they are saying is that perhaps they should be thinking about expanding the investment policies for their core bond managers. This has led plan sponsors to really put a focus on manager skill. Today, are plan sponsors willing to go with a smaller bond manager if that manager can demonstrate greater skill than the larger managers? Absolutely."
One consultant who did not wish to be identified said the average, compound annualized return of active core bond managers over the past seven years is 6.9% (gross of fees), while the Lehman Aggregate Bond index returned 7.1%.
According to performance data supplied by InvestorForce.com, Wayne, Pa., BlackRock, PIMCO and Western Asset produced annualized five-year returns of 7.6%, 7.9%, and 8.2%, respectively, in their core bond strategies. Delaware Investments, Lord, Abbett and Weiss Peck & Greer's core bond strategies returned 8.1%, 7.9% and 7.8%, respectively.
Greg Moore, director of manager research at Segal Advisors, New York, agreed that searches for active core bond managers have become more competitive, and that general underperformance versus the Lehman Aggregate has forced many institutional investors to look for alternatives.
PIMCO, BlackRock and Western Asset managed a combined $282 billion in active core bonds as of Jan. 1, according to data provided by InvestorForce. That's about 40% of the estimated $688 billion outsourced to money managers by institutional investors, according to InvestorForce data.
By contrast, the four smaller managers interviewed for this story manage a combined $12.2 billion in active core bonds.
"We can be more opportunistic because of our size," said Dan Vandivort, co-head of fixed income at Weiss, Peck & Greer. "For example, with the yield curve flattening, we were recently able to overweight the medium end of the curve in our portfolio. Because of our size, we were very easily able to do that in a couple of days. It would have taken a large manager six months to do that."
Robeco manages about $7 billion in active core bonds; Mr. Vandivort said the firm has doubled its core fixed-income assets since 2003.
Fiduciary Trust Co. International, New York, has about $1.2 billion in active core bonds under management. Michael J. Materasso, global head of fixed income, said: "There are lots of opportunities for smaller managers who are more nimble and can participate in bottom-up credit selection plays. Those are very important components in terms of managing the credit portion of a core bond portfolio."
"We believe all of our competitors have good investment processes," said Robert Gerber, director of taxable fixed income at Lord, Abbett & Co., Jersey City, N. J., which manages about $1.5 billion in active core bond assets. "The advantage we have over them is that when you're really big, you have to do things differently. When you're big you have to rely on macro strategies, such as interest rate or duration bets, and you have to get that right all the time. We're not forced into that. We can look for independent sources of return through credit selection."
Ryan Brist, co-chief investment officer of fixed income at Delaware Investments, said a smaller firm is in a better position to serve clients by focusing on the mortgage-backed and corporate bonds portion of a benchmark, such as the Lehman Aggregate. "In finals presentations, there's PIMCO and BlackRock and other niche firms. It's an open market, and we love the competition," said Mr. Brist. Delaware manages about $2.5 billion in its active core bond strategy.
"The advantage we have over our competitors is that our process is very bottom-up driven. We have over 40 people dedicated to research. We think we can add value through our security selection in corporates and MBS."
Officials at both PIMCO and BlackRock contend, however, that being large gives them advantages. Calls to Western Asset were referred to Barry Bilson, a spokesman for Western Asset's parent, Legg Mason Inc., Baltimore, who declined to comment.
"The first people who typically are called with inventory (by sell-side bond traders) are the bigger trading partners. PIMCO, BlackRock, WAMCo are going to see opportunities first and get the best liquidity and service," said Barbara Novick, managing director and head of new business development at BlackRock, which manages about $70 billion in core bond mandates. "Ten years ago, Wall Street firms provided liquidity from inventory. Today, they run lighter positions and they look for big holders of liquidity.
"We're built on relative value in our core bond product and we take moderate interest rate and currency bets. We know what we're doing and we like what we're doing."
Ms. Novick also rebutted the notion that because of its size, BlackRock cannot service clients as well as a smaller firm. "Customization is BlackRock's middle name," she said. "We have made huge investments in systems, and as a result we are able to create custom benchmarks and custom portfolios to meet different investment guidelines."
John Wilson, director of North American business development at PIMCO, agreed size should not be equated with performance.
He referred to a white paper the firm published two years ago titled "Bigger is Better," written to counter the argument that a smaller manager can handle credit selection better. "Without question, a $20 billion bond manager can restructure assets more quickly than a $200 billion manager. However, speed is more important to a short-term, trading-oriented manager than to a long-term, value player like PIMCO," said the paper. "A hallmark of PIMCO is our long-term, secular style of investing, and that style means that our risk targets tend to be relatively stable and evolve slowly."