Long-duration portfolios push their way up

Long-duration bond strategies led the list of top-performing fixed-income managers for the year ended Sept. 30, according to Morningstar Inc.'s separate account/collective investment trust database.

The third quarter “was quite a shake-up,” said Nicholas Sundberg, Chicago-based data analyst at Morningstar Inc.

“Only one (strategy) managed to stay on the (one-year) list: Pacific Investment Management Co.'s Long-Term Bond — Long Credit strategy,” he said.

All 10 leaders in the overall domestic fixed-income universe for the most recent 12 months were long-duration strategies; for the five years ended June 30, seven of the top 10 were high-yield bond strategies. In fact, high-yield bonds had dominated the rankings for eight straight quarters.

Falling high-yield third-quarter returns contributed to the change, Mr. Sundberg said. Domestic high-yield bonds in Morningstar's universe returned a median -1.79% in the quarter, down from 2.42% in the second quarter and 3.01% in the first quarter, respectively. The Credit Suisse High Yield index returned -1.79% for the third quarter.

Limited-, intermediate- and long-duration strategies “all managed to stay positive” in the third quarter but were down from previous quarters, Mr. Sundberg said. The third quarter “was the most volatile of the year,” he said. “Almost every asset class had a difficult time.”

Long-duration bonds in Morningstar's universe returned a median 0.77% in the third quarter, down from 4.74% and 6.29% in the second and first quarter, respectively.

The median return for the overall domestic fixed-income universe for the year ended Sept. 30 was 4.47%. The Barclays Capital Government/Credit index returned 4.08% for the period.

NISA Investment Advisors LLC's 15+ STRIPS strategy, which invests in zero-coupon securities with a maturity date of 15 years or more, and NISA's long-duration government-only consolidated strategy ranked first and second for the year, with gross returns of 20% and 16.7%, respectively.

The purpose of the strategies is to manage the interest rate risk in pension liabilities, said Jess B. Yawitz, CEO and chairman at St. Louis-based NISA. Mr. Yawitz attributed the strategies' success to the current low interest rate environment. “Interest rates have come down dramatically” year to date, Mr. Yawitz said. “Long duration (bonds) are going to get tremendous returns during that environment.”

Following NISA on the one-year list was Hoisington Investment Management Co.'s macroeconomic fixed-income strategy with a gross return of 15.4%.

The strategy tries to capture the inflationary expectation component of risk-free, long-term Treasury rates, said Lacy Hunt, chief economist and executive vice president at Austin, Texas-based Hoisington. “We try to make the correct duration expectation based on inflation expectations,” Mr. Hunt said.

Currently, the strategy is invested in long-duration Treasuries because the inflation rate and expectations are trending down, Mr. Hunt said. Mr. Hunt predicts this trend will continue into 2015 and perhaps beyond.

Rounding out the one-year list for the year ended Sept. 30 was PIMCO's long-term bond - long credit strategy and Standish Mellon Asset Management LLC's long duration multisector return-seeking strategy with gross returns of 14.9% and 14.6%, respectively.

The names in the five-year ranking were more constant quarter over quarter, Mr. Sundberg said. Five of the top 10 strategies remained the same from the June 30 ranking, and high-yield approaches held a total of seven spots.

In first place was Pyramis Global Advisors LLC's high-yield commercial mortgage-backed securities strategy with a five-year gross return of 16.8%. (All returns for periods of more than one year are compounded annualized.) Pyramis is a subsidiary of Fidelity Investments.

About 20% of the portfolio consists of CMBS issued in the aftermath of the credit crisis, said Steve Rosen,Pyramis portfolio manager. “(We were) a big buyer of CMBS newly issued in 2010 and 2011,” Mr. Rosen said. “Prices were low and underwriting was most prudent” which led to “a nice portfolio of bonds.”

Specifically, the team purchased collateralized debt obligations, said David Bagnani, also a portfolio manager. “Prices of those instruments fell precipitously during the crisis. Post-crisis we were able to uncover and take advantage of a few deals that had great opportunities,” Mr. Bagnani said.

Mr. Rosen further attributed the strategy's success to its focus on fundamentals. A group of analysts inspect properties and tour markets to help identify the best opportunities, Mr. Rosen said. “They are our eyes and ears on the ground,” Mr. Rosen said.

Another Pyramis strategy, the long corporate composite, ranked 10th on the one-year list with a gross return of 14%.

That strategy is used primarily by U.S. pension funds that are pursuing a liability-driven strategy, said John Houston, a portfolio manager based in Merrimack, N.H.

“The investment process includes bottom-up and top-down considerations and both played a part in one-year returns,” Mr. Houston said.

For bottom up,the portfolio team focuses on “sectors and individual credits that are going through theprocess of credit repair,” Mr. Houston said. He identified the U.S. banking system and U.S. life insurers as examples of sectors on which the team is focusing. “There's a lot of good progress being made in the U.S ... (and) assuming a steady policy performance from the Federal Reserve, that U.S. expansion has, I think, the stamina to continue into next year,” Mr. Houston said.

He is more cautious on the international picture, however.

“I think the policy coordination struggles in Europe are far from being resolved and the dramatic policy struggle in Japan, with their deflationary risk post-consumption tax, they're struggling to reflate the economy,” Mr. Houston said.

In second and third places on the five-year list were two TCW Group strategies — securitized opportunities and opportunistic mortgage-backed securities — with gross returns of 15.2% and 15%, respectively.

The securitized opportunities strategy was constructed “to perform well over a wide distribution of outcomes with very little sensitivity to U.S. interest rates,” said Scott Austin, managing director and portfolio manager at Los-Angeles-based TCW.

The strategy uses a diversified set of well-collateralized securitized credit, including non-agency residential mortgages, small balance commercial, student loans, shipping containers, structured settlements, aircraft and collateralized loan obligations, Mr. Austin said. “The opportunity set is growing and evolving,” he said.

TCW's opportunistic MBS strategy focuses on non-agency residential mortgage-backed securities. “The asset class continues to produce risk adjusted value with fundamental downside protection and considerable upside optionality,” Mr. Austin said.

In the collective investment trust universe, J.P. Morgan Asset Management's JPMCB Long Credit Fund claimed the top spot with a net one-year return of 14.12%. BlackRock Investment Management's Long Corporate Bond Index came in second, returning a net 14.1%.

Rounding off the top five were Wells Fargo Fund Management's Liability Driven Sol II, with a net return of 13.8%; and J.P. Morgan's JPMCB Long Duration Investment Grade and Long Duration Credit strategies with net returns of 13.1% and 12.9%, respectively.

The one-year median return for the collective investments was 4.1%.

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. n