Top-performing fixed-income managers: Long-term bonds cement leadership, push high yields aside

Long-term bond strategies continued to be the runaway top performers for the year ended Dec. 31, according to Morningstar Inc.'s separate account/collective investment trust database.

The top 10 performing separate account strategies were all long-term bonds, and the top seven were long government bond strategies. The long-bond strategy dominance completes a drastic change from the year ended June 30 when high-yield strategies made up six of the top 10.

“I think the message of the fourth-quarter top performing managers is pretty clear. The long-duration asset class and long government are by far the best performers in 2011,” said Adam Baranowski, team lead of Morningstar's separate account database. “Overall, domestic fixed-income strategies as a whole significantly outperformed their equity brethren.”

Overall domestic fixed-income separate account portfolios had a median 6.36% return for the year ended Dec. 31 while the median domestic equity return came in at -0.56%. The Barclays Capital Government/Credit index had a return of 8.74% for the year ended Dec. 31 while the Barclays Capital Long Government/ Credit Bond index returned 22.49%.

Long government portfolios easily had the highest median return among bond strategies for the year at 26.11%, followed by long-term bonds at 17.63%, Mr. Baranowski said.

“It's not that they have the secret sauce or anything, but it's more of that asset class just performing well,” Mr. Baranowski said of the six long-bond strategies that remained in the top 10 from the third quarter. “With long-duration strategies, the main risk involved is sensitivity to interest rates raises. Low interest rate changes bode well for that category.”

Inflation-protected bonds had a median return of 12.72%. The lowest median return category was money market portfolios at 0.37%.

High yield was the top performer for the fourth quarter, bringing in median returns of 5.86%. Long government had a quarterly median return of 1.84%, Mr. Baranowski said, while all domestic fixed-income strategies had a median return of 1.27%.

There was an unusually high amount of repeat performers from the quarter-earlier ranking among the top 10 managers. Six of the top 10 strategies for one-year returns ended Sept. 30 and seven of the top 10 for the five-year returns remained on the list for the periods ended Dec. 31.

“That doesn't happen too often,” Mr. Baranowski said. “It means both have short- and long-term track records in performance.”

The common thread among the top 10 in the overall ranking was the propensity for long-duration strategies. Of portfolios with the highest average effective duration, or the weighted average of the maturities of the underlying bonds, six of the seven highest were in the top 10 performing portfolios and eight were in the top 16. The median average effective duration for the domestic fixed-income universe as a whole was 4.26. The median average effective duration for the one-year top 10 list was 16.26, Mr. Baranowski said.

“There is a strong positive correlation between average effective duration and the one-year performance,” Mr. Baranowski said.

NISA Investment Advisors LLC had three of its portfolios in the top 10 for one-year returns; two of those made the five-year list as well. The NISA 15+ STRIPS strategy had the top overall fixed-income return with a gross return of 51.09% for the 12 months ended Dec. 31. The strategy invests in Treasury STRIPS — separate trading of registered interest and principal of securities — zero-coupon securities that do not mature for at least 15 years, said Jess B. Yawitz, CEO of St. Louis-based NISA. It also finished second in five-year returns at 14.54%. (All figures for periods of more than one year are compound annualized).

Right behind the STRIPS strategy for both one-year and five-year returns was the NISA Long Duration Government Only Consolidated portfolio, which had a one-year return of 49.98% for second place and a five-year return of 14.39% for third. Its Long Duration Government/Credit Consolidated portfolio finished ninth in one-year returns at 26.65%.

“In a falling interest-rate environment, those portfolios can't help but perform well,” Mr. Yawitz said. “The main determinant of absolute returns in these portfolios is the clients' decision to choose a long-duration benchmark.”

Following the top two NISA strategies in one-year performance was the Hoisington Investment Management Co. Macroeconomic Fixed Income Composite, which returned 40.06% for the year. It also ranked ninth for five-year returns at 12.63%. The strategy makes its investment decisions based on the multiyear trend in the domestic inflation rate. Lacy Hunt, executive vice president and vice chairman of the strategic investment committee at Austin, Texas-based Hoisington, said the portfolio's investment technique relies on the Fisher equation — that the nominal interest rate is equal to the real interest rate plus the expected inflation rate, which Mr. Hunt said is heading toward zero over the next few years.

“We positioned ourselves with a very long duration portfolio of close to 20,” Mr. Hunt said. “We felt, and have felt for a long time, that the U.S. economy is suffering from the effects of extreme indebtedness.”

The beginning of 2011 saw the portfolio down 10% following a wave of negative sentiment toward the Treasury market, but the “economy had a poor year and the inflation rate came down,” Mr. Hunt said. He added the strategy only invests in Treasuries — T-bills or TIPS — and goes all the way out on the yield curve. About half of the portfolio is concentrated in long-coupon Treasuries and the other half in zero coupons, both in the 20- to 30-year range.

“For the time being, we think long duration is the place to go ... but we are constantly checking every day where to be on the curve.”

Coming in at fourth for both one- and five-year returns was Hillswick Asset Management LLC's Long Duration Government strategy, which returned 33.6% and 13.61%, respectively. Anders Ekernas, chief investment officer, founder and chairman of Stamford, Conn.-based Hillswick, said the portfolio changed duration to go 25% longer than the benchmark based on the belief that risk aversion was on the rise and that GDP and earnings expectations would be revised lower than originally expected.

“Over the past five years, what worked best was probably our active sector-weighting adjustments,” Mr. Ekernas said. “In 2011, we extended duration and took on more interest-rate risk in April on the reasoning that the consensus expectations were too optimistic.”

Mr. Ekernas said the portfolio always has a significant weighting in Treasury coupons or STRIPS as well as owning a fair amount of government-owned and sponsored entities that provide additional yield, in addition to investment-grade corporate bonds. Looking forward, the portfolio is holding about 8% of its assets in cash reserves in anticipation of a default by Greece and subsequent bank runs from other European countries mired in debt.

“I think we will see another risk-aversion scenario kick in,” Mr. Ekernas said. “We're holding on to a fair amount of cash to take advantage of that.”

Rounding out the top five performers for the year was Jennison Associates LLC with its Active Long Government strategy, at 30.32%.

TCW Group's Securitized Opportunities Strategy led the top five-year performers with a 20.36% return. Also on the top 10 list were six strategies from the one-year ranking.

The TCW strategy invests in residential and commercial mortgage-backed securities and asset-backed securities without using borrowing to enhance returns, said Bryan Whalen, managing director, U.S. fixed income, and head of the MBS division in Los Angeles.

“We feel free to move where the best opportunities are in the marketplace,” Mr. Whalen said. “We have more flexibility than a core fixed-income portfolio ... and have no regard to the Barclays aggregate index.”

Mr. Whalen said the strategy is currently positioned with a two-thirds emphasis to the non-agency MBS sector with the remaining assets split between agency MBS and ABS, a position he acknowledged is far higher than he anticipates being in five years from now for the best total return opportunities. The percent of non-agency holdings increased in the second half of 2008 with a peak in late 2009 before coming slightly down since then, he said. The portfolio is actively managed with about half to two-thirds annual turnover.

“We really focus on granularity in the portfolio and diversification,” Mr. Whalen said. “Last year was risk off and we were still able to generate pretty good returns considering the opportunity set for the strategy.”

Following Hillswick to round out the top five for five-year returns was Clark Capital Management's Navigator Fixed Income Total Return strategy at 13.18%.

For five years, the median overall domestic fixed-income return in Morningstar's data was 6.65% while the Barclays Capital Government/ Credit index had a return of 6.55%.

For the fixed-income U.S. collective investment trust universe, the top one-year performers were BlackRock Inc.'s 20+ Treasury bond index fund at 33.86%, followed by Pyramis Global Advisors' Long Duration collective investment trust at 22.13%. Rounding out the top five were Wilmington Trust's WTFSC Long Duration portfolio, 19.28%; Pyramis' Long Corporate Pool, 17.6%; and BlackRock's Long Corporate Bond Index commingled fund, 17.08%. The median was 7.03% for the year.

The five-year leaders were Wilmington Trust's WTFSC Long Duration, with an annualized 12.01%; BlackRock's 20+ Treasury, 11.26%; Pyramis' Long Duration CIT, 10.02%; BlackRock's Long Corporate, 8.47%; and Associated Bank Intermediate Bond fund, 7.8%. The five-year median was 6.52%.