High-yield strategies showing no sign of giving up dominance

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

Nine of the top 10 fixed-income portfolios in the separate account universe for the 12 months were high yield, while an ultrashort fixed-income strategy took the overall top spot.

The median return of all domestic high-yield strategies was 7.65%, up from the year-end median return of 7.54% as of Dec. 31. The Credit Suisse High-Yield index returned 7.67%.

The 12-month median return for overall fixed-income strategies was 0.73%, while the Barclays Capital Government/Credit index returned -0.26% in the year ended March 31.

The new rankings illustrate the continued dominance of high yield,which accounted for eight of the top 10 overall domestic fixed-income strategies for the year ended Dec. 31.

Ranking first in the March 31 listing was Western Asset Management Co.'s U.S. index-plus strategy, reporting a gross return of 22.7% for the 12-month period.

Also, for the second quarter in a row, Los Angeles-based WAMCO's U.S. index-plus strategy took first place as the top overall strategy for five years, reporting an annualized gross return of 29.01% for the five years. The strategy consists of a short-duration bond component intended to add value while minimizing risk, along with a synthetic index component using derivatives for equity exposure.

Officials at WAMCO declined to comment.

New to the top 10 list and ranking second for the year ended March 31 was DDJ Capital Management LLC's strategic income plus composite strategy, with a gross return of 14.76%.

Much of the success of the strategy is due to its less constrained nature, according to David J. Breazzano, president and chief investment officer of the Waltham, Mass.-based firm. “I think the overall philosophy is this is the strategy at DDJ that is the least constrained for us, so it allows us to use all our tools to generate returns,” Mr. Breazzano said in a telephone interview.

“Of the different buckets that we have in the fund, probably the best contributors were post (re-organization) or levered equities,” Mr. Breazzano said. “The fund has the ability to do that and they were a great contributor for the last 12 months.”

Another contributor to the strategy's success is the fact it is a concentrated portfolio, holding only 35 to 40 names. Strong security and credit selection can make much more of a significant impact as opposed to some strategies that might have 200 or 300 different positions, really overdiversifying, he said.

Ranking third for the second quarter in a row was Morgan Stanley Investment Management Inc.'s global high-yield strategy, with a gross return of 14% for the year ended March 31.

The strategy focuses on high-yield opportunities that have no more than $1 billion in outstanding debt, with about 125 to 135 issuers in the portfolio. About 85% of the names owned fall within the middle-market category, and the remaining 15% with large names.

About 80% of the portfolio's holdings are from Morgan Stanley's U.S. high-yield strategy and 20% come from the firm's European-only high-yield strategy.

Richard Lindquist, New York-based managing director, global head of high yield, said in a telephone interview the strategy stayed consistent in the first quarter, repeating the level of success it saw in 2013.

“Generally our strategy was pretty much the same,” Mr. Lindquist said. “Nothing much changed from 2013 into the first quarter. Our fund is still focused on middle-market credits and we still have a pretty big overweigh to single B's and triple C's.”

“(We are also) still the same on double Bs. I think eventually, when rates rise, that part of the market will probably ... will be hurt the most because that has the longest duration.”

High yield in general has benefited as a “safe haven,” with flows from investors leaving emerging markets debt, although that might be changing, Mr. Lindquist said. “More recently it seems — just in the past few weeks — emerging markets funds have been getting some money back in for the first time for quite a while,” he said.

“But then you have the constant issue with Russia and (President Vladimir) Putin,” he added, referring to the current political crisis in Ukraine. “It's more of a day-to-day thing there.”

“People are also concerned about a slowdown in China,” Mr. Lindquist said.

Ranking fourth for the year is Franklin Templeton Investments' global high-yield strategy, with a gross return of 12.6%.

Eric Takaha, San Mateo, Calif.-based senior vice president and director of corporates and high yield at Franklin Templeton, said in a telephone interview that an emphasis on research is behind the success of the strategy.

“We have a large group of internal research analysts that drive our process,” said Mr. Takaha. “Security selection is driven by the recommendations by our in-house analysts.”

The research-based approach capitalizes on dislocations in high-yield fixed income and features exposure to the U.S., the U.K. and the eurozone with a broad spectrum of quality.

Higher beta, low defaults and high exposure to energy have helped as well.

“If you look over the past year in general, some of the higher beta, a bit more of the aggressive portion of the high-yield markets has been successful,” Mr. Takaha said.

“We had a bit of a higher beta at the start of 2013, and that certainly provided some good relative performance in the first part of the year.”

Also, “defaults have been pretty good given all the refinancing that has gone on in the past three or four years,” he said.

Ranking fifth was Shenkman Capital Management Inc.'s multistrategy separate account with a gross return of 11.84% for the year ended March 31.

The New York-based firm is a research-intensive, bottom-up fundamental credit shop that relies on proprietary analytical tools rather than ratings agencies to valuate the creditworthiness of a company, said Nicholas Keyes, senior vice president, principal and director of new business development,

This separate account is designed to be an unconstrained multisector fixed-income strategy that can generate positive returns, according to Mr. Keyes.

Justin W. Slatky, principal and senior portfolio manager at Shenkman Capital, said the strategy brings together “bank loans, high-yield bonds, convertibles and what we refer to as opportunistic credit.”

The lead portfolio managers of the four areas meet on a quarterly basis to allocate the capital among them. Performance in the past year was primarily driven by second liens within bank loans as well as convertibles.

Going into 2014, the product areas are more evenly distributed within the strategy, Mr. Slatky said. “Of the asset classes, we're probably most concerned about the second-lien market given the rally we've seen in credit, and given the risk rally we're seeing a bit of a risk-loving appetite,” Mr. Slatky said.

For the five years ended March 31, ranking second after WAMCO's U.S. index-plus strategy was Manulife Asset Management North America Ltd.'s U.S. high-yield fixed-income strategy, with a gross annualized return of 24.53%.

The median return for the five years ended March 31 for overall fixed-income strategies was an annualized 6.23%, while the Barclays Capital Government/Credit index returned 17.46%.

For collective investment trusts, J.P. Morgan Asset Management's distressed debt opportunities fund led the way with a net return of 21.09% for the year ended March 31, followed by Shenkman Capital Management's Four Points multistrategy collective investment trust, which had a 10.83% net return.

The median return for overall fixed-income collective investment trusts for the year ended March 31 was 0.4%, while the five-year median return was 5.52%.