Some bond managers emerge from the financial crisis fog

Some global fixed-income managers are touting their rebirth: Additions to investment staff, tweaks to investment process and improvements to risk management have righted the ship and delivered strong post-crisis performance, bond firm executives say.

Now, as the next few quarters wipe the poor performance of 2008 and early 2009 from three-year track records, these managers are hoping their improvements will attract new clients.

Unfortunately, it's not that simple, warn investment consultants, who are looking much more closely at what managers have learned from the crisis than how well they've performed.

Aberdeen Asset Management PLC, AllianceBernstein LP, Pacific Investment Management Co. LLC and Western Asset Management Co., among others, were hurt by poor performance and outflows through the crisis, but have taken steps to turn things around. Each has improved performance, but that might not be enough for some to recoup assets.

Strong global bond performance in the past 2½ years has been “largely a function of the market” for most managers, said Moustapha Abounadi, director and head of fixed-income research at consultant Rogerscasey Inc., Darien, Conn. “The things that have gotten those managers in trouble — risk assets — have come back strongly in 2009 and 2010.”

Ed Britton, London-based senior investment consultant and head of fixed-income manager research at Towers Watson & Co., said: “Good three-year performance will hide an awful lot of bad ways of getting there. Particularly now, performance can be even more misleading if you don't look at the whole picture.” That's because an extreme market drop in 2008, followed by an extreme rebound in 2009, make it harder to judge whether returns were a result of manager skill or luck.

Managers realize performance isn't everything.

“Performance is your ticket to the dance. Once you get to the dance, you need to distinguish yourself from your competitors,” said James W. Hirschmann, CEO and president of WAMCO, Pasadena, Calif.

At Mercer LLC, researchers look at a manager's ability to generate investment ideas, build portfolios and implement them, and at how they manage the overall business. “By analyzing these four factors qualitatively, we believe we are able to assess if a manager is able to beat their desired benchmark on a continuous basis,” Paul Cavalier, London-based principal and head of fixed-income manager research, said in an e-mailed response to questions.

Similarly, at Aon Hewitt, performance is a forward-looking indicator, as the consultant qualitatively evaluates whether good returns are repeatable in the future based on the investment process, said Mette Charles, senior investment research consultant in London.

After suffering poor performance, both relative to benchmark and peers, “we looked across our bench and tried to make some strategic additions to our team” where expertise was missing, said Stephen Walsh, chief investment officer at WAMCO. A silver lining of the crisis was that it shut down hedge funds' poaching of talent from bond managers, so a richer recruitment pool was available post-crisis, he said.

WAMCO also hired Boston Consulting Group to evaluate its investment process, and boosted its risk management capabilities. “Underlying all of this was a desire not to change our investment philosophy,” which is a value-oriented, long-horizon approach, Mr. Walsh said.

The firm is a “good example” of how to turn around poor performance, said a consultant who spoke on the condition of anonymity. “They beefed up their risk management function tremendously and made it a much more important part of the process,” the consultant said.

WAMCO's global core full-discretion strategy has delivered average annualized returns of 15.7% each of the past two years through March 31, outperforming the Barclays Capital Global Aggregate index (hedged to U.S. dollars) by almost 11 percentage points each year, according to data from eVestment Alliance, Marietta, Ga. That compares favorably to WAMCO's five-year annualized returns of 4.31% as of March 31, which were 64 basis points behind the benchmark.

WAMCO also turned around its performance relative to peers, rising to the 12th percentile for two-year annualized returns as of March 31 from the 95th percentile in five-year returns. There are 17 strategies in eVestment's unhedged global universe. WAMCO ran $4.7 billion in the strategy as of March 31, down 43% from $8.3 billion two years prior.

PIMCO also boosted its risk management in portfolios by examining underlying risk factors that are driving returns, and assessing where liquidity could be an issue, said Joseph V. McDevitt, managing director and head of PIMCO's London-based business in Europe. The firm's global strategy had invested in securities that eventually regained value, but “the effect of the crisis on these "money-good' securities was tremendous in terms of mark-to-market” accounting, he said.

PIMCO ranked in the 67nd percentile among global unhedged bond managers in eVestment Alliance's universe of about 40 managers in 2007, but dipped to 76th in 2008. It rose to 23th in 2009, and to 31st in 2010. Institutional assets, which had dropped about 20% to $13.8 billion in 2009, returned to their pre-crisis level of $17.4 billion as of March 31, according to eVestment Alliance.

“A number of managers have brought the investment risk considerations closer to the decision-making and portfolio-construction process since the liquidity crisis,” said Aon Hewitt's Ms. Charles. “Also, a handful of managers have added a new factor into their investment process, which would consider market sentiment as well as market technicals,” such as the supply and demand for securities.

Gino Perrina, Seattle-based head of fixed-income research at Russell Investments, said it was important for managers to stick to their “core strengths,” and that some managers have performed well after the crisis without making changes to teams or process.

That was the case at AllianceBernstein, where performance in its global strategy was hurt in 2008 primarily by timing, according to Arif Husain, London-based director of U.K. and European fixed income.

“In 2008, performance wasn't so good because, having been underweight risk going into the crisis, we began adding risk too early,” he said. After a re-evaluation midcrisis, his team doubled down on risk, which has propelled returns post-crisis.

For calendar year 2008, AllianceBernstein's global-plus strategy lost 4.79%, an underperformance of 9.5 percentage points vs. its benchmark, putting it at the 93rd percentile among eVestment's universe. However, the annualized return for the two years ended March 31 was 14.54%, an annualized outperformance of 5.86 percentage points, good for eighth percentile.

At Aberdeen, Paul Griffiths, London-based global head of fixed income, has been focused on turning around performance since taking over in early 2009. He's overseen improving risk management, making credit databases global and adding a macroeconomic top-down element to the investment process. And as of March 31, all bond strategies were topping their benchmarks. “From that perspective, we're very encouraged,” he said.

Regarding Aberdeen's global strategy, “We've done a lot to improve communication among our teams” which are spread out over Asia, London and the U.S., Mr. Griffiths said. He's looking to create a virtual “Facebook-style wall” on which team members can jot investment ideas at any time, regardless of their location.

Returns in Aberdeen's global bond strategy have suffered for some time, underperforming its Barclays Capital Global Aggregate (unhedged) benchmark by 22 basis points on average over the past seven years. However, the two-year annualized return was 12.74% as of March 31, more than four percentage points ahead of the benchmark. That was good for the 25th percentile in eVestment's universe.

But investment staff turnover — and the integration of Credit Suisse Asset Management's bond team in 2009 — have enhanced consultants' unease with Aberdeen. “There was a lot more than just performance,” said the consultant speaking anonymously. “We need more time to get reacquainted with them and to build confidence in their process.”

Aberdeen's Mr. Griffiths feels the firm has “turned a corner” regarding flows, as outflows have slowed; “the trend is definitely turning,” he said. However, “we've got some work to do to engage consultants,” he acknowledged.