LOS ANGELES — Payden & Rygel’s focus on high-quality bonds, a boon five years ago when market volatility spiked, is facing growing scrutiny from clients as performance has lagged.
In an e-mail response to questions that spokeswoman Kimberly Tipton attributed to the firm’s executive management team, Payden & Rygel said the market’s recent speculative run has hurt some strategies in the short term, but many consultants and clients continue to appreciate the firm’s investment style, aimed at “dampening the volatility produced by the riskier allocations in a plan’s overall portfolio.”
On Feb. 16, the $40 billion Illinois Teachers’ Retirement System, Springfield, cited underperformance in terminating its $666 million active core-plus mandate with the Los Angeles-based fixed-income manager, and some consultants see potential for additional defections.
Market watchers are of two views: those who see Payden & Rygel as a good money manager whose style is momentarily out of favor, and those who argue the firm’s capacity for managing risk has fallen behind rivals in the battle to serve alpha-hungry investors.
On the margin, the ranks of naysayers appear to be swelling.
One senior investment consultant who requested anonymity said his clients may terminate the firm this year: Payden & Rygel’s emphasis on the above-median quality of its bond portfolios has been undermined by below-median returns in the riskier asset classes clients are counting on to squeeze more alpha from their fixed income allocations, he said.
For example, Payden & Rygel’s active core-plus strategy, with $5.9 billion of the firm’s $55.7 billion in assets under management at the end of 2005, returned 3.91% gross of fees during 2006, trailing its Lehman Aggregate bond index benchmark by 42 basis points. With separate account fees of roughly 20 basis points, the strategy’s excess return, before fees, of 22 basis points a year for the 10 years through Dec. 31 would amount to an index-like return.
Similarly, the firm’s high-yield bond strategy, with $1.7 billion in assets at the end of 2005, trailed its ML U.S. High Yield Cash Pay benchmark by 270 basis points for calendar year 2006, and delivered a compound return, before fees, of 9 basis points over the benchmark since its January 1998 launch.
‘Great sales tool’
Payden & Rygel’s pitch about avoiding risk “is a great sales tool when people are very well funded, but when you’re underfunded and need returns to get out of that hole, it’s not a great story,” the senior investment consultant said.
After years of steady growth, Payden & Rygel’s assets under management ended 2006 at $54.1 billion, down $1.6 billion from the year before, according to the company’s numbers.
According to Atlanta-based eVestment Alliance, Payden & Rygel’s net inflows were strongest between 2001 and 2003, when the manager pulled in an average of $4.5 billion in net new client money each year.
James P. Sarni, a managing principal with Payden & Rygel, said in an interview that his company’s focus on the highest-quality issuers helped buoy its strategies to “the top of the heap” between 2000 and 2002, aided by the fact its portfolios weren’t holding the paper of big companies that imploded during that time, including WorldCom Inc. and Enron Corp.
Mr. Sarni said Payden & Rygel’s asset decline during 2006 relates more to the volatility of flows from cash-rich corporations than to outflows from the firm’s long-only fixed-income and equity strategies.
Still, while the firm continues to deliver benchmark-beating results for the short-term fixed-income strategies that account for more than 50% of its assets under management, some consultants see its weaker results in riskier asset classes as a symptom of what ails the firm.
Simply put, Payden & Rygel avoids risk, while competitors such as Western Asset Management Co. and BlackRock Inc. manage risk, said one consultant who declined to be named.
“Historically, they’ve had a strong, strong bias to higher quality parts of the fixed-income market,” said Michael Rosen, a principal with Angeles Investment Advisors, a Santa Monica, Calif., investment consultant. That helped when the market was roiled by the credit blowups, but on balance, he said, the firm hasn’t delivered market-beating returns.
The consultant who didn’t want to be named said, “We’ve been terminating them everywhere we can.”
More outperformance
Some observers expect Payden & Rygel to outperform again when the current prolonged stretch of low volatility ends. Mr. Sarni said that’s certainly the expectation within the firm, and the volatility seen on Wall Street since last week should serve to remind investors that there are environments where Payden & Rygel’s strategies will do “quite well.”
That view seems to be well represented among some of the firm’s big public fund clients.
Ken Lambert, investment officer with the $17 billion Nevada Public Employees’ Retirement System, Carson City, said even with performance lagging during the past year, the $645 million active U.S. core bond portfolio Payden & Rygel manages for Nevada exceeded its benchmark on a 10-year basis, and system officials remain confident in the firm.
Robert Feinstein, deputy CIO of the $32 billion Maryland State Retirement and Pension System, Baltimore, while declining to comment specifically about his fund’s $706 million core-plus mandate with Payden & Rygel, said Maryland remains “very happy” with the way its overall core-plus allocation is being managed. Since Maryland hired the firm in 2003, it has yet to match or outperform its benchmark.
Meanwhile, consultants see signs the firm is working to expand its product lineup to appeal more directly to alpha-hungry institutional investors.
Payden & Rygel executives don’t want to change their core principles, but “I think they realize they have to offer some alternatives to the way they do things … to be able to say ‘if you need some alpha, let’s look at this,’” said the West Coast consultant.
