Ultrashort claims top 2 spots, but high yield maintains domination

High-yield strategies, along with ultrashort-duration strategies, dominated the list of top-performing fixed-income managers for the year ended Dec. 31, according to Morningstar Inc.'s separate account/collective trust database.

Eight of the top 10 fixed-income portfolios in the separate account universe for the year ended Dec. 31 were high yield.

For the quarter ended Dec. 31, the median return for all domestic high-yield strategies was 3.48%, up from 2.29% the previous quarter and -1.22% in the second quarter of 2013. The median high-yield return for the year ended Dec. 31 was 7.54%.

Long-duration strategies, meanwhile, continued to lag considerably behind other domestic fixed-income strategies, with a median return of -6.48% for the year ended Dec. 31.

However, long duration did perform better in the fourth quarter when compared to intermediate- and limited-durations strategies, according to Andy Kwon, data analyst at Chicago-based Morningstar.

“The median for long (duration) in Q3 was 0.1% but increased to 0.58% (in Q4),” Mr. Kwon said in a telephone interview. “It's a significant increase in the median from third quarter to fourth, (but) it's still not performing better than high yield.”

The median returns for intermediate-duration strategies and limited-duration strategies fell to 0.21% and 0.28%, respectively, for the fourth quarter, while third-quarter median returns for intermediate duration and limited duration were 0.72% and 0.52%, respectively.

Despite the dominance of high-yield strategies in the top 10, the top two strategies both fell within Morningstar's ultrashort bond category.

For the year ended Dec. 31, the top-performing fixed-income strategy was the TCW MetWest AlphaTrak, an ultrashort strategy, with a gross return of 34.09%.

While Morningstar classifies the strategy as ultrashort, TCW considers it primarily an S&P 500 futures strategy, according to Bryan Whalen, Los Angeles-based managing director, U.S. fixed income at TCW Group Inc.

“Basically the concept is we, effectively through futures, take the S&P 500 exposure, but by using the futures you're left with a fair degree of cash,” Mr. Whalen said. “And an option is to invest that in money markets and cash-like instruments, and therefore at the end of the year your returns will look very similar to the S&P 500. That's kind of the neutral option.”

There are also two options to utilize credit, Mr. Whalen said.

“You can get long credit through fixed income or you can get defensive. You can put on trades that can benefit from a spread widening event on fixed income.”

In 2013, “we invested the majority of the cash in low-duration fixed-income credit investments and that meant a good deal of exposure to high-quality low-duration non-agency mortgage-backed securities,” Mr. Whalen said. “Our next kind of highest exposure was in investment-grade credit overweight to financials, and then the next largest sector, all kind of the same, a mix of ABS, MBS and agency MBS.”

“Spreads compressed during the course of the year, contributed to positive returns (and) created the return of the overall fund when you added in the S&P return,” Mr. Whalen said.

Western Asset Management Co.'s U.S. index-plus strategy, also classified by Morningstar as an ultrashort bond strategy, came in second, reporting a gross return of 33.44% for the year ended Dec. 31. The strategy consists of a short-duration bond component intended to add value while minimizing risk, along with a synthetic index component utilizing derivatives for equity exposure.

Morgan Stanley Investment Management captured two places in the overall top five fixed-income managers, with its global high-yield strategy ranking third with a 14.89% gross return for the year ended Dec. 31, and its U.S. high-yield strategy ranking fifth with a 14.04% gross return.

The firm's high-yield strategies focus primarily on middle-market high-yield opportunities with $1 billion or less in outstanding debt, according to Richard Lindquist, managing director, global head of high yield in New York.

The U.S. high-yield strategy has “125 to 135 issuers in that portfolio,” Mr. Lindquist said in a telephone interview. About 85% of the names they own fall within that middle-market category. The 15% of the strategy with “large names,” Mr. Lindquist said, is partly due to liquidity reasons and some unique bonds and situations such as favorable covenants.

About 80% of the global high-yield strategy consists of names from the U.S. high-yield strategy. Also included in the global high yield is a European high-yield component.

The firm has a European-only high-yield strategy managed by Leon Grenyer, London-based executive director and head of European high yield and “he'll hand-pick 20 to 30 bonds from that strategy for the global fund,” Mr. Lindquist said.

“Global's target is 160 names,” Mr. Lindquist said. “We also have the ability to buy outside of the U.S. and Europe for the global fund, and for that allocation we opportunistically buy dollar-denominated Latin American and Asian high-yield bonds.”

Mr. Lindquist said, overall, high yield had a very good year in 2013, especially in the second half of the year.

“In 2013 and as well this year, people are worried about higher interest rates,” Mr. Lindquist said. “They're not worried about high-yield defaults. They remain relatively low, and the outlook is expected to remain low.”

Mr. Lindquist said investors saw high yield as a “safer haven than emerging markets corporate debt.”

“You're not giving up a ton of yield to go into (high yield), but you're getting lower volatility. You're not dealing with the whole currency situation either,” Mr. Lindquist said. “High yield also benefited from the outflows from emerging markets debt in the second half of 2013.”

Advisors Asset Management Inc.'s credit opportunities strategy was ranked fourth, with a gross return of 14.62% in the year ended Dec. 31.

The strategy invests in below-investment-grade bonds and invests from a contrarian viewpoint, said Brian Gilbert, Monument, Colo.-based first vice president and portfolio manager.

“We do a lot of credit research, a lot of discussions in the portfolio management group about a lot of areas that get a lot of negative publicity in the headlines and that's where we go for the investments,” Mr. Gilbert said in a telephone interview.

Among the sectors the strategy emphasizes are “basic materials, energy, mining, shipping,” which continue to perform well for the strategy. Another key action was a move into convertibles in March and April of 2013, Mr. Gilbert said.

“The conversations with clients I had (were) they're all looking for more yield, but really what is the risk tolerance, moving toward the BB-(rated) space?” Mr. Gilbert said. “They were talking about moving to unconstrained areas or to lower-quality bonds.”

“When we feel we're in a recovery phase, we're going to step even further down the credit scale,” Mr. Gilbert said. “This is what the general public was looking at in 2013.”

For the five years ended Dec. 31, WAMCO's U.S. index-plus strategy took first place for the first time, with an annualized gross return of 24.67%.

Coming in second was Nomura Corp. Research and Asset Management Inc.'s high-yield total return institutional strategy, with an annualized gross return of 23%.

The rest of the top five for the five years ended Dec. 31 were PENN Capital Management Co. Inc.'s distressed total-return strategy, at an annualized gross return of 22.67%; TCW's MetWest AlphaTrak, 22.09%; and Federated Investors Inc.'s high-yield fixed-income with equity exposure strategy, 21.17%.

For collective investment trusts, FMT/Delaware's high-yield opportunity strategy led the overall rankings, with a one-year net return of 8.42% as of Dec. 31. Following that was Transamerica's high-yield bond strategy, with a one-year net return of 8.11%. The median return for collective investment trusts for the year was -1.43%.

FMT/Delware's high-yield opportunity strategy also had the highest five-year annualized net return among CITs, at 16.67%, followed by the FMT/PIMCO high-yield strategy at 14.95%. The median return for collective investment trusts for the five years ended Dec. 31 was 4.48%.

All of the data for Pensions & Investments' quarterly Top-Performing Managers report are provided from Morningstar's global separate account/collective investment trust database. For information on the database, please contact [email protected] or call 312-384-4087.