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Special Report

High-yield strategies continue their rule over the fixed-income universe

Tad Rivelle
TCW Group’s Tad Rivelle

High-yield strategies once again dominated the domestic fixed-income rankings of top-performing managers for the year ended June 30, according to Morningstar Inc.'s separate account/collective investment trust database.

For the second quarter in a row, nine of the top 10 fixed-income strategies in the separate account universe were in Morningstar's high-yield bond category for the 12-month period. It also was the third straight quarter dominated by high-yield strategies; eight of the top 10 in the year ended Dec. 31 were high yield.

High yield also ruled the five-year rankings, with eight of the top 10 domestic fixed-income strategies for the five years ended June 30.

The Credit Suisse High Yield index returned 13.04% in the year and an annualized 6.74% in the five years ended June 30. The median domestic high-yield return in the Morningstar universe was 11.49% for the year and an 6.74% in the five-year period. All multiyear returns are annualized.

The median return for the entire domestic fixed-income Morningstar universe was 0.93% for the year ended June 30 and 2.81% for the five-year period.

Emory Zink, fund analyst, fixed-income strategies at Morningstar in Chicago, said in a telephone interview that first-quarter themes continued into the second. The Federal Reserve had raised rates in March and did so again in June. Still, despite higher rates, the yield curve continued to flatten.

"That was kind of expected," Ms. Zink said. "When you have that flattening, investors had already priced in expectation for rate rises, so there wasn't a drastic move at the long end of the curve."

The Federal Open Market Committee agreed on June 14 to increase the federal funds rate by 25 basis points to a 1% to 1.25% range, echoing moves made in March and December 2016 that also raised rates by 25 basis points each.

Despite the supremacy of high-yield strategies, the top-ranked manager in the domestic fixed-income category for both the year and five years ended June 30 was in Morningstar's ultrashort bond category.

TCW Group Inc.'s AlphaTrak strategy returned a gross 26.93% in the 12 months and 17.26% in the five years ended June 30.

It was the second quarter in a row that the AlphaTrak strategy lead the one-year gross returns of domestic fixed-income managers.

"It is basically a fund that is involved in something that used to be referred to as portable alpha," said Tad Rivelle, chief investment officer of fixed income and fixed-income portfolio manager at Los Angeles-based TCW Group, in a telephone interview. "It's a portfolio of S&P 500 futures that provides index tracking to the S&P."

"It uses the exposure to the S&P 500 and the return of that," he said. "However, there's a very interesting element with the respect to the use of S&P futures. It means unlike when you buy a portfolio of the 500 stocks in the physical form, in the futures form you are engaged in a transaction where you have delayed delivery, so you have to only put an initial 3% margin down. With the 97% you didn't otherwise use, we deploy it to use as short-term (fixed-income) securities."

Top-performing managers: overall U.S. fixed income
One-year returnCategoryGross
TCW Alpha TrakU.S. SA ultrashort bond26.93%25.80%
DDJ Total Return Credit II CompositeU.S. SA high-yield bond20.15%17.75%
DDJ U.S. Opportunistic High Yield Comp.U.S. SA high-yield bond19.53%18.92%
DCM High YieldU.S. SA high-yield bond18.73%18.14%
MacKay Select High Yield CompositeU.S. SA high-yield bond18.17%17.59%
Nuveen High Yield Fixed IncomeU.S. SA high-yield bond16.88%16.30%
PineBridge U.S. High Yield Bond CompositeU.S. SA high-yield bond16.22%15.71%
Logan Circle High YieldU.S. SA high-yield bond15.42%14.85%
Diamond Hill High YieldU.S. SA high-yield bond15.19%14.62%
Shenkman Capital Multi-Strategy Comp.U.S. SA high-yield bond14.97%14.12%
Five-year returnCategoryGross
TCW Alpha TrakU.S. SA ultrashort bond17.26%16.78%
TCW Opportunistic MBSU.S. SA high-yield bond10.94%10.16%
MacKay Select High Yield CompositeU.S. SA high-yield bond9.65%9.11%
Flaherty & Crumrine Separate Managed AccountU.S. SA intermediate-term bond9.25%8.73%
Nomura NCRAM HY Total Return Inst'lU.S. SA high-yield bond9.21%8.67%
Oaktree European High Yield BondsU.S. SA high-yield bond9.20%8.66%
Morgan Stanley (MS) U.S. High YieldU.S. SA high-yield bond9.19%8.26%
DCM High YieldU.S. SA high-yield bond9.07%8.53%
Lord Abbett High Yield OpportunisticU.S. SA high-yield bond8.99%8.85%
Federated Opportunistic High Yield Comp.U.S. SA high-yield bond8.80%8.26%

The S&P 500 returned 17.9% in the year ended June 30. Those short-term fixed-income securities are actively managed to enhance the returns above the index.

TCW also captured second place in the ranking of the top managers for the five years ended June 30. Its opportunistic mortgage-backed securities strategy ranked second with a gross return of 10.94%.

The strategy "is about 90% in non-agency mortgages," Mr. Rivelle said, much of which is split between legacy subprime mortgages and "alt a" mortgages, which are a notch above subprime in terms of credit quality but below prime. "This is an asset class that basically went right through the mill in 2008, 2009 — it was ground zero in the meltdown."

"The valuation proposition is that those who could probably identify the wheat from the chaff were really able to earn enormous returns."

DDJ Capital Management LLC, Waltham, Mass., ranked second and third for the year ended June 30 with two strategies in Morningstar's high-yield category. The Total Return Credit II Composite returned a gross 20.15%, and the U.S. Opportunistic High Yield Composite returned a gross 19.53%.

Both strategies use a deep value approach that prioritizes individual security selection over sector weighting.

In the first quarter, the strategies ranked third and fifth, respectively, for the year ended March 31.

David J. Breazzano, chief investment officer, president and lead portfolio manager of the total return credit and opportunistic high-yield strategies, said in a telephone interview that good credit selection and research have contributed to the success of the strategies.

Mr. Breazzano said the strategies have a more concentrated portfolio than most high-yield managers, with about 70 to 80 names.

"We do extremely thorough research to identify those names that are just mispriced by the markets," he said. "If we do not believe the company has adequate credit cushion to afford its capital structure and we're concerned about the company's reason to exist — such that a low-market-share/high-cost producer that is performing OK in a good economic environment but just go away in a challenging economic environment — we don't need to hold it."

DuPont Capital Management Corp., Wilmington, Del., ranked fourth for the year ended June 30, with its high-yield strategy, which returned a gross 18.73%. The strategy also ranked eighth overall for the five years ended June 30, with a gross return of 9.07%.

Ming Shao, director of fixed income investments at DuPont Capital Management, said the strategy's long-term approach makes its appearance in the one-year listings rather unique, but said last year's recovery in oil prices contributed greatly to the one-year returns.

"If you go one year back, let's say second quarter of 2016, probably all the things we're still buying probably underperformed right away," Mr. Shao said. "Then after the middle of the year, you start to see oil sort of start to recover above $40 and later on after a while above $50, so what happens in this case (is) some of the corporate investment we bought distressed actually went through restructuring."

Ranked fifth was MacKay Shields LLC's select high-yield composite with a one-year gross return of 18.17%. It also ranked third for the five years ended June 30, with a 9.65% gross return.

"The Select portfolio is a concentrated portfolio of generally higher-yielding bonds," Andrew Susser, New York-based executive managing director and head of high yield, said in a telephone interview. "It doesn't use leverage and it basically has performed well really due to good credit selection. Our team is very much about specific credit picks and really understanding the companies we invest in."

"The biggest thing was just avoiding the real blowups, and we did that by adhering to our process and making sure there was sufficient asset coverage," Mr. Susser said, "so that when the world changed and oil prices went down and commodities went down, we didn't hold the bonds that needed $100 oil to survive."

Looking forward, over the larger high-yield market, Mr. Susser said, "right now spreads are rich on a historical basis, which kind of makes sense when you look at equity prices making new highs every day and interest rates being low and volatility being abnormally low."

For the five years ended June 30, behind the two TCW Group strategies and MacKay Shields strategy, Flaherty & Crumrine, Pasadena, Calif., ranked fourth with its separate managed account in Morningstar's intermediate-bond category, with a gross return of 9.25%, and New York-based Nomura Corporate Research and Asset Management Inc.'s high-yield total return institutional strategy ranked fifth at 9.21%.

In the collective investment trust universe, meanwhile, DDJ Capital Management's total return credit I composite CIT led all domestic fixed-income managers for the year ended June 30, with a net return of 17.38%. It also led all domestic fixed-income managers for the five years ended June 30, with an annualized net return of 8.03%.

The median return for fixed-income CITs was 0.68% for the year and 2.78% for the five years ended June 30.

Ranked second overall for the year ended June 30 was Shenkman Capital Management Inc.'s four-points multistrategy trust, with a net return of 14.26%, followed by State Street Global Advisors' U.S. high-yield bond index CIT at 12.19%; Fidelity Institutional Asset Management's high-yield core institutional trust, at 11.97%; and J.P. Morgan Asset Management (JPM)'s JPMCB corporate high-yield trust, at 11.75%.

For the five years ended June 30, ranked second was Amalgamated Bank's ultra construction loan CIT, with a net return of 7.21%, followed by J.P. Morgan Asset Management's JPMCB corporate high-yield trust, at 7.18%, Eaton Vance (EV) Management (EV)'s high-yield trust at 7.09% and PGIM Fixed Income's high-yield fund at 7.07%.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Aug. 3.