Long-duration bond strategies continued to dominate Morningstar Inc.'s domestic fixed-income separate account/collective investment trust database, occupying eight of the top 10 spots for the year ended Sept. 30.
In the previous quarter's ranking, long-duration strategies occupied all top 10 spots for the 12 months ended June 30.
Falling interest rates continued to benefit long-duration strategies, said Emory Zink, fund analyst, fixed-income strategies, at Chicago-based Morningstar. The median return for broad long-duration strategies tracked by Morningstar was 14.98% for the 12 months ended Sept. 30, slightly above the Bloomberg Barclays U.S. Long Government/Credit Bond index at 14.66%.
Looking at other fixed-income sectors, the Bloomberg Barclays U.S. Municipal Bond index returned 5.58% for the year, “bolstered by strong fundamentals and robust demand,” Ms. Zink said, and the Bloomberg Barclays U.S. Corporate High-Yield Bond index returned 12.73%. The median return for Morningstar's overall domestic fixed-income universe was 5.42% for the year and domestic high-yield bonds, 10.37%.
While falling interest rates and tightening credit spreads helped put long-duration strategies on top for the year, the third quarter revealed some setbacks.
The Bloomberg Barclays Long U.S. Treasury index returned -0.36% in the quarter, which Ms. Zink attributed in part to investor anxiety over an expected Federal Reserve interest rate hike and the presidential election. During the same period, the Bloomberg Barclays Municipal Bond index returned -0.3%, its first negative quarterly return in more than a year, and the Barclays U.S. Corporate High-Yield index, “settling” from the energy stresses experienced in the first half of the year, returned 5.55%, Ms. Zink said.
TCW Group Inc.'s AlphaTrak strategy occupied the No. 1 spot on the one- and five-year rankings with gross returns of 20.31% and 18.25%, respectively. (Returns for all periods of more than one year are compound annualized.)
Although Morningstar classifies AlphaTrak as an ultrashort bond strategy, TCW's Stephen M. Kane said it is really an “enhanced equity indexing strategy.”
Portfolio managers aim to exceed the total return of the Standard & Poor's 500 index by investing in a combination of short-term bonds and S&P 500 index futures, said Mr. Kane, Los Angeles-based group managing director and generalist portfolio manager in the U.S. fixed-income group at TCW.
While the majority of the strategy's one- and five-year returns came from holding S&P 500 futures (the S&P 500 returned about 15.4% and 16.4%, in those periods, respectively), the fixed-income portion, which includes investment-grade corporate bonds, asset- and mortgage-backed securities, high-yield bonds and other non-Treasury securities, benefited from excess yield above that of the London interbank offered rate, tightening credit spreads and falling interest rates, Mr. Kane said.
Another TCW strategy — Opportunistic Mortgage-Backed Securities — ranked sixth on the five-year list with a gross return of 10.64%.
That strategy focuses on the non-agency mortgage-backed securities market, which over the past five years has been the best-performing fixed-income sector, Mr. Kane said.
Many of the loans that originated between 2004 and 2007 were poorer in quality and defaulted very quickly during the financial crisis. The falling prices on these loans created “tremendous return opportunities,” Mr. Kane said.
More recently, however, performance drivers have been “less about the market being oversold and cheap, and more about positive fundamentals,” Mr. Kane said.
The “worst borrowers that took out 2007/2008 loans defaulted very quickly” in 2009, 2010 and 2011, leaving a “significantly improving pool of borrowers,” Mr. Kane said. “And then, of course, the housing market has turned and the economy has grown and recovered.”
Combing through this pool of borrowers requires a large investment in technology and people, Mr. Kane added. On TCW's 65-member fixed-income investment team, about 30 individuals are focused on securitized products.