Fixed income: High-yield bonds still dominate, but sector loses some ground

High-yield bonds led the way in the top 10 overall fixed-income rankings for the year ended March 31, but not with the domination they displayed in prior quarters, according to Morningstar Inc.'s separate account/collective investment trust database.

Strategies in Morningstar's high-yield category accounted for four of the top 10. Two short-term and ultrashort bonds strategies also were in the top 10, as were one long government and one intermediate-term strategy.

High yield had dominated the one-year rankings for the past two quarters, taking six of the top 10 in the year ended Dec. 31 and six in the year ended Sept. 30.

Two noticeable trends are that the median return of fixed-income strategies in the separate account universe has been trending downward during the past two quarters, and more limited duration bond strategies have been far more successful during that time period, according to Andy Kwon, data analyst at Morningstar in Chicago.

For the year ended March 31, the median return among all domestic fixed-income separate account portfolios was 5.15%; the median return for the first quarter was 0.32%. The Barclays Capital Government/Credit index returned 4.56% for the 12 months and -0.16% for the quarter. The Credit Suisse High Yield index returned 12.43% in the year and 2.94% in the three months.

Separating median returns by duration, bond strategies in Morningstar's limited-duration category had a median return of 0.29% in the quarter ended March 31, while intermediate-duration had a median return of 0.28% and long duration had a median return of -1.18%.

The median returns of all three duration categories have been decreasing in the previous two quarters. For example, the median long-duration return was 3.96% in the third quarter and went down to 1.08% in the fourth quarter.

The lineup for the top 10, however, did not change significantly from the year ended Dec. 31.

“If you look at the top 10... it's sort of (in a) stable downward trend instead of something volatile,” said Mr. Kwon.

The top performing fixed-income separate account manager in the year ended March 31 was TCW Group Inc., which led the way for the second quarter in a row with its Opportunistic MBS high-yield bond strategy, with a gross return of 29.4%.

Bryan Whalen, Los Angeles-based managing director, U.S. fixed income, said the success of the strategy has its roots in the decision at the end of 2011 to raise the risk profile of the portfolio, which is exclusively focused on non-agency mortgage-backed securities.

“In the fourth quarter of 2011, prices took a dip down and at that point, we got pretty aggressive,” Mr. Whalen said.

TCW Group's securitized opportunities long-term government bond portfolio came in third for the year, with a gross return of 20.56%.

“(This) strategy's meant to be a bit broader. It really allows us to invest in any securities markets, anything that qualifies,” said Mr. Whalen.

In second place was the opportunistic mortgage-backed securities short-term bond portfolio of New York-based Brookfield Investment Management Inc., with a one-year gross return of 26.3%.

It is the second consecutive quarter the portfolio has been in second place.

The strategy primarily focuses on sectors and securities within mortgage-backed and commercial mortgage-backed securities that are more sensitive to better-than-expected improvements in either residential or commercial real estate markets, according to Michelle Russell-Dowe, managing director and head of structured products.

“These non-guaranteed MBS included a focus on sectors, such as subprime MBS, which benefited from the overall improvement in real estate markets, and on option (adjustable-rate mortgage) MBS, which benefited from regional exposures which were heavily focused on California and Arizona,” said Ms. Russell-Dowe.

“Both California and Arizona represent regions which had a significant reduction in housing inventory and as a result, saw a significant improvement in home prices in 2012.”

Coming in fourth for the year was DuPont Capital Management's high-yield portfolio, with a gross return of 19.21%.

Ming Shao, Wilmington, Del.-based director of fixed-income investments, said the firm is more of a value shop and the strategy takes a bottom-up approach.

“Interestingly enough, the last 18 months have been very volatile, and it's been very hard to know where the value is,” said Mr. Shao. “We use a relative yardstick to try to figure out where the opportunities are, and things start to show up. We're watching Europe for a long time just like everyone else.”

“At the end of Q3 2011, actually everything came together. The value really showed up in a sense. We saw companies that were European domiciled were cheaper by more than two or three points,” he said.

“So what we do? We say we're looking for fundamentals, especially the companies with sound global businesses independent of where they're domiciled.”

Coming in fifth for the year ended March 31 was Western Asset Management Co.'s U.S. index-plus strategy, with a gross return of 17.59%.

The separate account consists of two components: a synthetic index component that uses derivatives to provide exposure to an equity benchmark, and a short-duration component that “employs a long-term value-oriented approach utilizing diversified strategies and all sectors of the fixed-income market in an attempt to add value while minimizing risk,” according to a company-provided description.”

The top 10 performers among fixed-income managers for the five years ended March 31 was split evenly, with five high-yield and five long-duration portfolios.

In that universe, TCW's securitized opportunities portfolio led the way with an annualized gross return of 21.36%.

Capital Management Group Inc.'s system research Treasury bond program came in second with 20.54%. (All returns for periods of more than one year are annualized.)

The rest of the top five for the five years ended March 31 were: Reams Asset Management Co. LLC's long-duration fixed-income portfolio, with 16.22%; First Eagle Investment Management LLC's high-yield portfolio, 15.76%; and PageOne Financial Inc.'s SIP portfolio, 15.33%.

For collective investment trusts, the top performing strategy for the second quarter in a row was Brandywine Global Investment Management's credit opportunity fund, with a one-year gross return of 13.82%, followed by Columbia Trust's high-yield bond fund at 13.29%.

Rounding out the top five collective investment trusts were: Neuberger Berman's high-yield bond fund, with a one-year gross return of 13.09%; Amalgamated Bank's ultra construction loan strategy at 12.92%; and J.P. Morgan Chase's high yield fund at 12.91%. n