A bearish bond market allowed cash and short-term managers to outperform longer term managers for the year ended Sept. 30.
According to the Pensions & Investments Performance Evaluation Report, cash and short-term separate account managers took nine of the top 10 spots for the year, with returns ranging from 7.2% to 3.5%.
The median limited duration manager in PIPER returned 1.7% for the period, while the median intermediate duration manager returned -1.4%.
Longer duration managers and the broad market as a whole fared worse. The median PIPER long duration manager returned -7.8%, while the median PIPER broad market account returned -3.3%, and the Salomon Broad Bond Index returned -3.2%.
Over the long term, long duration managers in the PIPER database performed relatively better, with the median manager posting an annualized return of 9.3% for the five years ended Sept. 30. During the same period, annualized returns were: 7.7% for the median limited duration separate account manager; 8.5% for the median intermediate duration manager; and 8.8% for the median broad market fixed-income manager. The Salomon Broad Bond Index had an annualized return of 8.5% for the five-year period.
But with the broad bond market declining since October 1993, investors were willing to pay a premium for liquidity, to the benefit of all types of short-term managers, said Daniel Dektar, principal and portfolio manager in the Chapel Hill, N.C., office of Smith Breeden Associates Inc. "The more liquid the portfolio, the better it looks this year," he said. Smith Breeden's Mortgage Short Duration account ranked fourth for the year ended Sept. 30, returning 4.51%, and fifth for the quarter, returning 1.64%.
Similarly, Henley Smith, chief investment officer and portfolio manager for Gabelli-O'Connor Fixed Income Management Co., said shorter-term highly liquid portfolios were able to outperform in the generally falling bond market.
Gabelli-O'Connor's Active Cash 1 Year and Active Intermediate 2 Year separate accounts ranked fifth and seventh, respectively, with returns of 3.98% and 3.54%, for the year ended Sept. 30. They ranked second-to-last and last for the three years ended Sept. 30, with annualized returns of 1.34% and 1.34%, when long duration portfolios were outperforming.
Tad Rivelle, portfolio manager for Hotchkis and Wiley, Los Angeles, said that before interest rates headed sharply higher earlier this year, many money managers were able to profit by investing with a duration longer than their benchmark's duration. More recently, with interest rates climbing, shorter duration portfolios were the ones outperforming, he said.
Hotchkis & Wiley's Low Duration separate account was ranked first for the year ended Sept. 30, returning 7.2%.
And within shorter-term portfolios, managers used different strategies to maximize performance in a down market, money managers said.
At GMG/Seneca Capital Management, San Francisco, portfolio managers invested in lower-rated and junk corporate bonds to limit the effects of the falling bond market in much of 1994, said Gail Seneca, managing partner. GMG/Seneca's Value Driven Fixed Income separate account was ranked 10th for the quarter, with returns of 1.5%.
Corporate bonds overall were boosted in that period by rising corporate profits, Ms. Seneca said. Within that group, "hospital names were extremely strong," she said. Hospital bonds have benefited from a consolidation within the industry and improved efficiency, which has in turn increased margins, she said.
Ms. Seneca said the firm also focused on callable bonds, which tend to fall less in bear markets because of their callability.
Similarly, investing in callable bonds was one of the ways managers at Hotchkis & Wiley invested in a market that didn't have "much value left," Mr. Rivelle said. Hotchkis & Wiley portfolio managers also invested in short-duration collateralized mortgage obligations with high coupons, he said.
Also, the firm tries to be opportunistic at all times in buying securities that may be temporarily mispriced because of a small issue size or other factors, he added. If possible, Mr. Rivelle said, the firm will try bond arbitrage, buying a bond from a dealer at one price and flipping to another at a higher price.
Mr. Dektar said Smith Breeden, which heavily uses mortgage-backed securities, had two primary strategies to keep its portfolio durations from extending beyond the firm's guidelines. It used caps and put options, and it dynamically rebalanced its portfolios as the market fell and interest rates rose, Mr. Dektar said. While it may look like the firm is giving up yield to pay for cap and put protection, the protection is worth it if the market falls, he said.
Extension of average life is a problem for mortgage-backed securities when rates are rising, because the expected duration of mortgage-backed securities increases as the assumed rate of mortgage prepayment slows.
Gabelli-O'Connor's general strategy of keeping its durations short, investing in highly liquid and high-quality short-term investments worked well for the firm in the recent market environment, Mr. Smith said.
